<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                  FORM 10-KSB
(Mark One)
[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 1998
                                      OR

[  ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

For the transition period from        to
                              --------  --------

                          Commission File No. 0-22287

                     CUMBERLAND MOUNTAIN BANCSHARES, INC.
--------------------------------------------------------------------------------
                (Name of Small Business Issuer in Its Charter)

          Tennessee                                          31-1499488
-------------------------------                          -------------------
(State or other jurisdiction of                           (I.R.S. Employer
incorporation or organization)                           Identification No.)

1431 Cumberland Avenue, Middlesboro, Kentucky                   40965
---------------------------------------------            -------------------
  (Address of principal executive offices)                    (Zip Code)

         Issuer's telephone number, including area code (606) 248-4584
                                                       ----------------

          Securities registered under Section 12(b) of the Act: None
                                                               ------

             Securities registered under Section 12(g) of the Act:
                    Common Stock, par value $0.01 per share
                    ---------------------------------------
                               (Title of Class)

         Check whether the issuer: (l) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports); and (2)
has been subject to such filing requirements for the past 90 days.  YES X  NO
                                                                       ---   ---
         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B in this form, and no disclosure will be contained to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

         State issuer's revenues for its most recent fiscal year: $11.9 million.

         The aggregate market value of the voting stock held by nonaffiliates of
the registrant based on the last sale of which the registrant was aware ($16.375
per share), was approximately $9.1 million as of July 31, 1998. Solely for
purposes of this calculation, the term "affiliate" refers to all directors and
executive officers of the registrant and all stockholders beneficially owning
more than 5% of the registrant's common stock.

         As of July 31, 1998, there were issued and outstanding 678,800 shares
of the registrant's common stock.

         Transitional Small Business Disclosure Format (check one):  YES   NO X
                                                                        ---  ---

                      DOCUMENTS INCORPORATED BY REFERENCE

         1. Portions of Proxy Statement for the 1998 Annual Meeting of
            Stockholders (Part III)
<PAGE>
 
                                    PART I

Item 1.  Description of Business
--------------------------------

         Cumberland Mountain Bancshares, Inc. Cumberland Mountain Bancshares,
Inc. (the "Company") is the holding company for Middlesboro Federal Bank,
Federal Savings Bank ("Middlesboro Federal" or the "Bank"). The Company was
organized on December 13, 1996 at the direction of the Board of Directors of the
Bank for the purpose of holding all of the capital stock of the Bank. On March
31, 1997, the Company completed its initial public offering. A total of 439,731
shares were sold in a subscription offering in connection with the conversion of
Cumberland Mountain Bancshares, M.H.C. (the "Mutual Holding Company") from
mutual to stock form and the reorganization of the Bank as a subsidiary of the
Company (collectively, the "Conversion and Reorganization"). An additional
239,069 shares were issued to the public stockholders of the Bank in exchange
for their shares of the common stock of the Bank. Shares of the common stock of
the Bank that had been held by the Mutual Holding Company were canceled. The
Company has no significant assets other than all of the outstanding shares of
the Bank, and the portion of the net proceeds from the offering retained by the
Company, and the Company has no significant liabilities. Management of the
Company and the Bank are substantially similar and the Company neither owns nor
leases any property, but instead uses the premises, equipment and furniture of
the Bank.

         The Company is a unitary savings and loan holding company which, under
existing laws, would generally not be restricted as to the type of business
activities in which it may engage, provided that continues to be a qualified
thrift lender ("QTL"). See "Regulation -- Regulation of the Company" for a
description of certain regulations applicable to the Company.

         The Company's principal executive office is located at the home office
of the Bank at 1431 Cumberland Avenue, Middlesboro, Kentucky 40965, and its
telephone number is (606) 248-4584.

         Middlesboro Federal Bank, Federal Savings Bank. Middlesboro Federal is
a federally chartered stock savings bank that was organized in 1994 as a
subsidiary of the Mutual Holding Company. Prior to that date, the Bank had
operated since 1915 in Middlesboro, Kentucky and since 1976 in Cumberland,
Kentucky.

         Middlesboro Federal is primarily engaged in attracting deposits from
the general public through its offices and using those and other available
sources of funds to originate loans secured by single-family residences located
in the counties where its offices are located. Such loans amounted to $68.3
million, or 57.04%, of Middlesboro Federal's total loan portfolio (before net
items). At June 30, 1998, Middlesboro Federal held $19.4 million in commercial
real estate loans at that date, representing 16.23% of total loans (before net
items). The other significant areas of lending activity by Middlesboro Federal
are multi-family real estate loans, construction loans, commercial business
loans and consumer loans which, as of June 30, 1998, represented $2.4 million,
or 2.02%, $2.3 million, or 1.9%, $10.7 million, or 8.92%, and $16.6 million, or
13.89%, respectively, of Middlesboro Federal's total loan portfolio. Middlesboro
Federal also makes substantial investments in United States Treasury and federal
government obligations and mortgage-backed securities which are insured by
federal agencies. As of June 30, 1998, the carrying value of U.S. Treasury and
government agency securities was $2.5 million and the carrying value of its
mortgage-backed securities portfolio, was $5.6 million.

         Middlesboro Federal is subject to regulation by the OTS, as its primary
federal regulator and by the Federal Deposit Insurance Corporation ("FDIC"),
which, through the Savings Association Insurance Fund ("SAIF") administered by
it, insures Middlesboro Federal's deposits up to applicable limits. Middlesboro
Federal is a member of the Federal Home Loan Bank ("FHLB") of Cincinnati, which
is one of the 12 banks which comprise the FHLB System.

         Middlesboro Federal's principal executive offices are located 1431
Cumberland Avenue, Middlesboro, Kentucky, 40965, and its telephone number is
(606) 248-4584.


                                       2
<PAGE>
 
Market Area

         The Bank considers its primary market area for its lending and deposit
services to be Bell and Harlan Counties in southeastern Kentucky where its
branches are located and the nearby counties of Clairborne, Knox and Union in
upper east Tennessee and western Lee County in Virginia. The Bank's immediate
market areas of Bell and Harlan Counties in Kentucky and Clairborne County in
Tennessee are predominately rural and lightly populated. Bell and Harlan
Counties were severely impacted by the decline of the coal-mining industry in
the 1980s which was formerly the area's largest employer. According to 1990
Census figures, 35.9% and 32.3% of the households in Bell and Harlan Counties,
respectively, were below the federal poverty line. Between 1980 and 1990, the
population of Bell County declined by 8.2% and the population of Harlan County
declined by 12.7%. The median household income in Bell County was estimated to
be $14,819 in 1996 ranking the county 110th in Kentucky in terms of household
income. Harlan County, with a median household income of $16,137, was ranked
102nd. The 1994 unemployment rate for Bell County was 7.9%. In terms of
employment, the largest industry in Bell County is currently health services.
The largest single employer in Bell County is a pork-processing plant. Coal
mining remains the largest employer in Harlan County. Knox and Union Counties in
Tennessee have more diversified economies and higher income levels than the
Bank's immediate market area, reflecting those counties' proximity to Knoxville,
the nearest population center.

Lending Activities

         General. The Bank's primary lending activity is the origination of
conventional mortgage loans for the purpose of constructing, purchasing or
refinancing owner-occupied, one- to four-family residential properties in its
primary market area. At June 30, 1998, one- to four-family mortgage loans
comprised $68.3 million, or 57.04%, of the Bank's gross loan portfolio. To a
lesser extent, the Bank originates construction loans, multi-family residential
and commercial real estate loans and has purchased whole loans and loan
participations to supplement its originations. The Bank also originates secured
and unsecured commercial and consumer loans.

         During recent years, the Bank has expanded the loan portfolio by
emphasizing originations in its primary market areas of Bell and Harlan
Counties, Kentucky and Claiborne, Knox and Union counties in Tennessee.
Management has also sought to diversify the loan portfolio through increased
origination of commercial mortgages and commercial loans. A significant portion
of the Bank's loan growth in recent years has involved loans secured by
properties in Knox County, Tennessee. Middlesboro Federal estimates that at June
30, 1998 its portfolio included approximately $47.7 million in loans secured by
properties in Knox County. Reflecting its prior strategy of supplementing local
originations with loan purchases from other parts of Kentucky, the Bank's loan
portfolio at June 30, 1998 also included approximately $3.3 million in purchased
mortgages secured by properties in Central Kentucky in the Lexington area.


                                       3
<PAGE>
 
         Set forth below is selected data relating to the composition of the
Bank's loan portfolio by type of loan at the dates indicated.
<TABLE> 
<CAPTION> 

                                                                              At June 30,
                                                          ---------------------------------------------------
                                                                  1998                          1997
                                                          -------------------           -------------------
                                                          Amount          %             Amount          %
                                                          ------       ------           ------       ------
                                                                       (Dollars in thousands)
<S>                                                       <C>          <C>              <C>          <C> 
Mortgage Loans:
   One- to four-family.................................   $  68,328    57.04%           $  54,590    52.59%
   Multi-family........................................       2,421     2.02                1,441     1.39
   Commercial..........................................      19,442    16.23               17,402    16.76
Construction:                                                                                       
   One- to four-family.................................       1,393     1.16                8,998     8.67
   Multi-family and commercial.........................         884     0.74                   --       --
Commercial.............................................      10,682     8.92                8,311     8.00
Consumer loans:                                                                                     
   Savings account.....................................       2,059     1.72                1,975     1.90
   Automobile..........................................       5,683     4.74                3,992     3.85
   Credit card.........................................         591     0.49                  580     0.56
   Other ..............................................       8,314     6.94                6,514     6.28
                                                          ---------   ------            ---------   ------
        Total loans....................................     119,797   100.00%             103,803   100.00%
                                                                      ======                        ======
                                                                                         
Less:                                                                                    
   Loans in process....................................        (913)                       (3,748)
   Discounts...........................................         (25)                         (126)
   Allowance for loan losses...........................        (798)                         (306)
                                                          ---------                     ---------
      Total............................................   $ 118,061                     $  99,623
                                                          =========                     =========
</TABLE> 

                                        4
<PAGE>
 
         Loan Maturity Schedule. The following table sets forth certain
information at June 30, 1998 regarding the dollar amount of loans maturing in
the Bank's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE> 
<CAPTION> 
                                                                Due after                                            
                                         Due during             1 through             Due after                      
                                       the year ending        5 years after         5 years after                    
                                        June 30, 1999         June 30, 1998         June 30, 1998          Total     
                                        -------------         -------------         -------------       ---------    
                                                                        (In thousands)                               
<S>                                     <C>                   <C>                   <C>                 <C>          
Real estate mortgage loans:                                                                                          
   One- to four-family................    $   1,009             $     883             $  66,436          $ 68,328    
   Multi-family.......................          128                   195                 2,098             2,421    
   Commercial.........................          803                 3,216                15,423            19,442    
Construction:                                                                                                        
   One- to four-family................        1,393                    --                    --             1,393    
   Multi-family and commercial........          884                    --                    --               884    
Commercial............................        3,961                 4,912                 1,809            10,682    
Consumer loans:                                                                                                      
   Savings account....................        2,059                    --                    --             2,059    
   Automobile.........................        1,998                 3,685                    --             5,683    
   Credit card........................          591                    --                    --               591    
   Other..............................        2,008                 5,183                 1,123             8,314    
                                          ---------             ---------             ---------          --------    
     Total............................    $  14,834             $  18,074             $  86,889          $119,797    
                                          =========             =========             =========          ========     
</TABLE> 

         The next table sets forth at June 30, 1998 the dollar amount of all
loans due one year or more after June 30, 1998 which have predetermined interest
rates and have floating or adjustable interest rates.
<TABLE> 
<CAPTION> 
                                                        Predetermined              Floating or
                                                            Rates               Adjustable Rates
                                                        -------------           ----------------
                                                                   (In thousands)
<S>                                                     <C>                     <C> 
Real estate mortgage loans:
   One- to four-family...............................    $    9,432                 $   57,887
   Multi-family......................................            --                      2,293
   Commercial........................................         5,735                     12,904
Construction:                                                      
   One- to four-family...............................            --                         --
   Multi-family and commercial.......................            --                         --
Commercial...........................................         6,721                         --
Consumer loans:                                                    
   Savings account...................................            --                         --
   Automobiles.......................................         3,685                         --
   Credit card.......................................            --                         --
   Other.............................................         6,306                         --
                                                         ----------                 ----------
     Total...........................................    $   31,879                 $   73,084
                                                         ==========                 ==========
</TABLE> 

         Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets. The average life of long-term loans is
substantially less than their contractual terms due to prepayments. In addition,
due-on-sale clauses in mortgage loans generally give the Bank the right to
declare a conventional loan due and payable in the event, among other things,
that a borrower sells the real property subject to the mortgage and the loan is
not repaid. The average life of mortgage loans tends to increase when current
mortgage loan market rates are substantially

                                       5
<PAGE>
 
higher than rates on existing mortgage loans and tends to decrease when current
mortgage loan market rates are substantially lower than rates on existing
mortgage loans.

         One- to Four-Family Real Estate Loans. The Bank's primary lending
activity consists of the origination of loans secured by owner-occupied, one- to
four-family residential properties located in its primary market area. At June
30, 1998, $68.3 million, or 57.04%, of the Bank's loan portfolio consisted of
loans secured by one- to four-family residential properties, of which $57.5
million, or 84.2%, carried adjustable interest rates. The Bank estimates that
the average size of the residential mortgages that it currently originates is
$95,000.

         The Bank originates both fixed-rate mortgage loans and adjustable-rate
mortgage loans ("ARMs"). Fixed-rate mortgage loans are originated for terms of
up to 15 or 20 years. ARMs are originated for terms of up to 30 years. The
Bank's one and three-year ARMs have interest rates that adjust every one and
three years, respectively, with a maximum adjustment of two percentage points
for any adjustment period and up to six percentage points over the life of the
loan. These loans are indexed to the weekly average rate on the one-year and
three-year U.S. Treasury securities, respectively, adjusted to a constant
maturity. The current margin is three percentage points. All loans originated by
the Bank are retained in the Bank's loan portfolio. At June 30, 1998, 55.9% of
the Bank's loans had remaining terms to maturity of 15 years or less.

         The Bank's lending policies generally limit the maximum loan-to-value
ratio on residential mortgage loans to a maximum of 89% of the lesser of the
appraised value of the underlying property or its purchase price. For loans
where the loan-to-value ratio exceeds 80%, the Bank charges an additional amount
equal to the incremental cost of private mortgage insurance. Such additional
amounts are added to the Bank's loan loss reserve. Originated loans in the
Bank's portfolio include due-on-sale clauses which provide the Bank with the
contractual right to deem the loan immediately due and payable in the event that
the borrower transfers ownership of the property without the Bank's consent.

         The retention of ARMs in portfolio helps reduce the Bank's exposure to
increases in interest rates. There are, however, unquantifiable credit risks
resulting from potential increased costs to the borrower as a result of upward
repricing of ARMs. It is possible that during periods of rising interest rates,
the risk of default on ARMs may increase due to the upward adjustment of
interest costs to the borrower. The Bank does not originate ARM loans which
provide for negative amortization. Although ARMs allow the Bank to increase the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the periodic and lifetime interest rate
ceilings contained in ARM contracts. In addition, since ARM interest rates can
be adjusted no more frequently than annually, the yield on the Bank's ARM
portfolio does not adjust as rapidly as market interest rates. Accordingly,
there can be no assurance that yields on the Bank's ARMs will adjust
sufficiently to compensate for increases in its cost of funds.

         Second Mortgages and Home Equity Lines of Credit. The Bank also
originates second mortgage loans and home equity lines of credit exclusively for
its existing one- to four-family first mortgage customers. At June 30, 1998,
$1.8 million, or 1.47%, of the Bank's loan portfolio consisted of second
mortgage loans and home equity lines of credit. Second mortgage loans are
generally underwritten on a fixed-rate basis with terms of up to 15 years and
are fully amortizing over the term of the loan. Second mortgages and home equity
lines of credit are generally subject to an 80% combined loan-to-value
limitation, including all other outstanding mortgages or liens. Generally, the
minimum loan amount for a second mortgage is $5,000. Home equity lines of credit
permit borrowers to borrow up to a pre-established limit during the five year
term of the line of credit. Payments of interest only are required during the
term with a balloon payment of all outstanding principal due at maturity. Home
equity lines of credit are underwritten on a variable-rate basis indexed to the
prime rate plus an increment.

         Commercial and Multi-Family Residential Real Estate Loans. At June 30,
1998, loans secured by commercial real estate and multi-family residential real
estate properties totaled $19.4 million and $2.4 million, respectively, and
represented 16.23% and 2.02%, respectively of the Bank's loan portfolio.
Commercial real estate loans are secured by churches, motels, office buildings,
retail stores, small shopping centers and other non-residential property. At
June 30, 1998, the Bank's largest outstanding commercial real estate loan was an
$897,000 loan secured by a convenience store in Farragute, Tennessee. The Bank's
multi-family residential real estate loans are secured by

                                       6
<PAGE>
 
residential property with up to 24 units. Substantially all of the Bank's
commercial and multi-family residential and commercial real estate loans are
secured by property located within the Bank's market area and were current and
performing at June 30, 1998.

         Commercial and multi-family residential real estate loans generally
have terms of up to 15 years and are underwritten on either a fixed or
adjustable-rate basis. Commercial and multi-family real estate loans are fully
amortizing over the term of the loan. Adjustable-rate commercial and
multi-family mortgages are indexed to the prime rate and adjust on a monthly or
annually basis. Loan-to-value ratios may not exceed 75% of the appraised value
of the underlying property. Commercial real estate loans which are secured by
raw land are limited to a maximum loan-to-value ratio of 65%. It is the Bank's
policy to obtain personal guarantees from all principals obtaining commercial
and multi-family real estate loans. In assessing the value of such guarantees,
the Bank reviews the individuals' personal financial statements, credit reports,
tax returns and other financial information. Generally, the Bank also obtains a
security interest in any related personal property and a standby assignment of
rents and leases.

         Multi-family and commercial real estate lending entails significant
additional risks compared to residential property lending. These loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans typically is dependent on the successful
operation of the real estate project. These risks can be significantly affected
by supply and demand conditions in the market for office and retail space, and,
as such, may be subject to a greater extent to adverse conditions in the economy
generally. To minimize these risks, the Bank generally limits this type of
lending to its market area and to borrowers with which it has substantial
experience or who are otherwise well known to management.

         With certain limited exceptions, the maximum amount that the Bank may
lend to any borrower (including certain related entities of the borrower) at any
one time may not exceed 15% of the unimpaired capital and surplus of the
institution, plus an additional 10% of unimpaired capital and surplus for loans
fully secured by readily marketable collateral. At June 30, 1998, the maximum
amount that the Bank could have loaned to any one borrower without prior OTS
approval was $2.2 million. Pursuant to OTS regulations, an institution may make
loans in excess of its lending limit up to an amount not to exceed the lesser of
$30.0 million, or 30%, of its unimpaired capital and surplus to finance the
development of residential housing units provided certain requirements are
satisfied. At June 30, 1998, the largest aggregate amount of loans that the Bank
had outstanding to any one borrower and their related interests was $1.2 million
and consisted of 4 loans including loans to purchase a business. The largest
single loan outstanding was an $897,000 loan secured by a convenience store
discussed above.

         Construction Loans. The Bank offers construction financing to qualified
borrowers for construction primarily of single-family residential properties and
to qualified developers for construction of small residential developments. The
Bank also provides construction financing for multi-family and commercial
properties. Construction loans are limited to a maximum loan-to-value ratio of
75% of the appraised value of the property on an "as-completed" basis. The
current policy of the Bank is to charge interest rates on its residential
construction loans that convert to a permanent loan at the Bank at the same rate
as its permanent loans. Loans to finance the construction of residential
property on a speculative basis and loans to finance the construction of
commercial properties are offered on a variable-rate basis only, with the rate
indexed to the prime rate plus a negotiated increment. The Bank is currently not
originating any new construction loans to finance the construction of
speculative properties and is limiting the origination of new construction loans
to borrowers with whom the Bank has had substantial prior experience due to the
significant time and other requirements associated with originating and
monitoring construction loans.

         Loan proceeds are disbursed during the construction phase (a maximum of
180 days) according to a draw schedule based on the stage of completion.
Construction loans are underwritten on the basis of the estimated value of the
property as completed and loan-to-value ratios must conform to the requirements
for the permanent loan. At June 30, 1998, $1.4 million, or 1.16%, of the Bank's
gross loan portfolio consisted of construction loans to fund the construction of
one- to four-family properties. Approximately half of all construction loans
originated by the Bank convert into permanent loans upon completion of the
construction phase.


                                       7
<PAGE>
 
         Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of construction cost proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the development. If the estimate of
the value proves to be inaccurate, the Bank may be confronted, at or prior to
the maturity of the loan, with a project having a value which is insufficient to
assure full repayment. The ability of a developer to sell developed lots or
completed dwelling units will depend on, among other things, demand, pricing,
availability of comparable properties and economic conditions. The Bank has
sought to minimize this risk by limiting construction lending to qualified
borrowers in the Bank's market area, limiting the aggregate amount of
outstanding construction loans and imposing a stricter loan-to-value ratio
requirement than required for one- to four-family mortgage loans.

         Commercial Loans. At June 30, 1998, the Bank had $10.7 million in
commercial business loans which represented 8.92% of the Bank's gross loan
portfolio. Under recent amendments to the Home Owners' Loan Act ("HOLA"), the
Bank is permitted to invest up to 20% of its assets in commercial loans provided
that amounts in excess of 10% are small business loans. The Bank's commercial
business lending activities are directed towards small businesses located in its
market area. Generally, the Bank's commercial business loans are secured by
assets such as inventory, equipment or other assets and are guaranteed by the
principals of the business. On a very limited basis, the Bank has engaged in
dealer floor-plan lending with a limited number of dealerships with which the
Bank has had substantial experience. Commercial business loans usually carry a
floating rate set at an increment over the prime rate and generally are
underwritten for a maximum of 15 years. Such loans are structured as term loans.

         The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value, and seeks to structure such
loans to have more than one source of repayment. The borrower is required to
provide the Bank with sufficient information to allow the Bank to make its
lending determination. In most instances, this information consists of at least
three years of financial statements, a statement of projected cash flows,
current financial information on any guarantor and any additional information on
the collateral.

         Consumer Loans. The Bank's consumer loans consist primarily of loans
secured by deposit accounts, automobile loans, unsecured personal loans and
credit cards, which represented 1.72%, 4.74%, 6.94% and 0.49% of its total loan
portfolio, respectively, at June 30, 1998. The Bank also makes boat loans and
home improvement loans pursuant to its consumer lending authority. The Bank has
recently emphasized consumer lending because of the higher yields on such loans.

         The Bank makes deposit account loans up to 80% of the depositor's
account balance. The interest rate is normally 2.0% above the rate paid on the
account and the account must be pledged as collateral to secure the loan.
Savings account loans are secured by demand notes and interest is due on a
semi-annual basis. The Bank's automobile loans are generally underwritten in
amount of up to 100% of the lesser of the purchase price of the automobile or
the loan value as published by the National Automobile Dealers Association. The
terms of such loans do not exceed 60 months and vary depending on the age of the
vehicle securing the loan. The Bank requires the borrower to insure the
automobile under a policy listing the Bank as loss payee. Boat loans are made up
to a maximum of $60,000. The maximum term of a boat loan is 60 months and will
vary depending on the age of the collateral. The Bank also makes unsecured
personal loans of up to $25,000. The terms of such loans do not exceed 60
months. Beginning in November 1995, the Bank began to offer VISA(R), MasterCard
(R) and VISA Gold (R) cards to qualified customers. Processing of the Bank's
credit cards is done by an unaffiliated third party which receives a fee for
such services. Equipment loans are made in amounts of up to 100% of the purchase
price and have a maximum term of 60 months depending on the age of the
equipment.

         Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed

                                        8
<PAGE>
 
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans. Such loans may
also give rise to claims and defenses by a consumer loan borrower against an
assignee of such loans such as the Bank, and a borrower may be able to assert
against such assignee claims and defenses which it has against the seller of the
underlying collateral.

         Loan Solicitation and Processing. The Bank's mortgage loans have
generally been originated by its loan officers, branch managers and senior
management officials. Loan originations are obtained from a number of sources,
including existing and past customers, members of the local community, and
referrals from attorneys, established builders and realtors within the Bank's
market area. In addition, the Bank purchases participations in loans originated
by other lenders and has purchased whole loans from an unaffiliated mortgage
banking firm. Upon receipt of a loan application from a prospective borrower,
the Bank reviews the information provided and makes an initial determination as
to whether certain basic underwriting standards regarding the type of property,
debt-to-income ratios and other credit concerns are satisfied. A credit report
and employment and other verifications are obtained to verify certain specific
information relating to the loan applicant's employment, income and credit
standing. For real estate loans, an appraisal of the property intended to secure
the loan is undertaken by an independent appraiser approved by the Bank. It is
the Bank's policy to obtain appropriate insurance protection on all real estate
first mortgage loans and to obtain a lawyer's opinion of title which insures
that the property is free of prior encumbrances. The borrower must also obtain
paid flood insurance when the property is located in a flood plain as designated
by the Department of Housing and Urban Development. It is the Bank's policy to
record a lien on the real estate securing the loan. Borrowers generally are
required to advance funds for certain items such as real estate taxes, flood
insurance and private mortgage insurance, when applicable.

         Secured loans in amounts of up to $125,000 may be approved by
individual loan officers. Secured loans between $125,000 and $250,000 and all
unsecured loans must be approved by a loan committee which consists of at least
three persons, either officers or directors. The loan committee meets weekly to
review and approve loans. All loans in excess of $250,000 must be approved by
the Board of Directors.

         Loan applicants are promptly notified in writing of the Bank's
decision. If the loan is approved, the notification will provide that the Bank's
commitment will generally terminate within 30 days of the approval. It has been
the Bank's experience that substantially all approved loans are funded.

         Loan Originations, Purchases and Sales. Most loans originated by the
Bank are intended to be held in the Bank's portfolio until maturity. The Bank is
not a qualified seller/servicer for the Federal National Mortgage Association
("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and generally
does not sell loans in the secondary market. Although the Bank uses FNMA/FHLMC
documentation for its residential mortgages, the loans in its portfolio would
generally not qualify for sale to FNMA or FHLMC under standard programs because
of the absence of title insurance and surveys. The Bank, however, has purchased
whole loans and participations in loans originated by other lenders which meet
FNMA/FHLMC criteria.

         In prior years, the Bank regularly purchased loans to supplement
lending opportunities in its immediate market area. Such loan purchases
generally involved residential mortgages originated by a mortgage broker located
in Lexington, Kentucky. Loan purchases have decreased in recent years due to the
increased emphasis on loan originations in its primary market area. At June 30,
1998, the Bank's loan portfolio included approximately $3.3 million in purchased
mortgages secured by residential properties in the Lexington area. All of such
loans are serviced by the originating broker.

                                        9
<PAGE>
 
         Generally, the purchase of participations and whole loans involves the
same risks as would the origination of the same types of loans as well as the
additional risks related to the Bank's lower level of control over the
origination and subsequent administration of the loans. The Bank has sought to
minimize such risks by employing more stringent underwriting standards in its
underwriting of purchased loans than required by its loan policy for loans
originated by the Bank. The Bank has never had to charge off any of its
purchased loans. At June 30, 1998, all of the Bank's purchased loans were
performing in accordance with their terms.

         Nonperforming Loans and Other Problem Assets. The Bank continuously
monitors its loan portfolio to detect signs of deterioration in credit quality
and to address potential and actual delinquencies. When a borrower fails to make
a payment on a loan, the Bank takes immediate steps to have the delinquency
cured and the loan restored to current status. When a loan is 10 days past due,
the borrower receives a written notification; a late charge is imposed on the
16th day of delinquency. If payment is not promptly received, the borrower is
contacted again both by telephone and in writing, and efforts are made to
formulate an affirmative plan to cure the delinquency. Loans that are 60 days
delinquent are generally referred to an attorney who contacts the borrower.
Loans generally are placed on nonaccrual status when they become 90 days past
due unless they are well secured and in the process of collection. Interest
accrued and unpaid at the time a loan was placed on nonaccrual status is charged
against interest income. The Bank will physically inspect all properties
securing nonaccrual loans. Subsequent payments would either be applied to the
outstanding principal balance or recorded as interest income, depending on the
assessment of the ultimate collectibility of the loan based on a number of
factors, including the type of loan, the creditworthiness of the borrower, the
quality of the security and prevailing market conditions. Generally, if the loan
continues in a delinquent status for 90 days or more, the Bank may initiate
legal proceedings. Consumer loans are charged off and referred to a collection
agency after they are delinquent 120 days.

         Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at its fair market value
less costs to sell. Any write-down of the property is charged directly to the
loan loss reserve.

                                       10
<PAGE>
 
         The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. At the dates shown, the Bank had no
restructured loans within the meaning of SFAS No. 114.

<TABLE> 
<CAPTION> 
                                                                         At June 30,
                                                                 --------------------------
                                                                   1998              1997
                                                                 --------          --------
                                                                       (In thousands)
<S>                                                              <C>               <C> 
Loans accounted for on a nonaccrual basis: (1)
  Real estate mortgage loans:
     Residential...............................................  $  1,729          $    601  
     Nonresidential............................................        --                --  
  Construction.................................................        --                --  
  Commercial...................................................        --                --  
  Consumer.....................................................        --                27  
                                                                 --------          --------  
        Total..................................................  $  1,729          $    628  
                                                                 ========          ========  
                                                                                             
Accruing loans which are contractually past due 90 days or more:                             
  Real estate mortgage loans:                                                                
     Residential...............................................  $     --          $     --  
     Nonresidential............................................        --                --  
  Construction.................................................        --                --  
  Commercial...................................................        --                --  
  Consumer.....................................................        71                75  
                                                                 --------          --------  
        Total..................................................  $     71          $     75  
                                                                 ========          ========  
                                                                                             
        Total nonperforming loans..............................  $  1,800          $    703  
                                                                 ========          ========  
Percentage of total loans......................................      1.50%             0.68% 
                                                                 ========          ========  
Other nonperforming assets.....................................  $     --          $     --  
                                                                 ========          ========   
</TABLE> 
--------------------
(1)      Nonaccrual status denotes loans on which, in the opinion of management,
         the collection of additional interest is unlikely. Payments received on
         a nonaccrual loan are either applied to the outstanding principal
         balance or recorded as interest income, depending on management's
         assessment of the collectibility of the loan.


         During the year ended June 30, 1998, gross interest income of $31,000
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the respective periods. Interest on such loans
included in income during such period amounted to $86,000.

         At June 30, 1998, there were no loans which are not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms and may result in disclosure as nonaccrual, 90 days past
due or restructured.

         Asset Classification and Allowance for Loan Losses. Federal regulations
require savings associations to review their assets on a regular basis and to
classify them as "substandard," "doubtful" or "loss" if warranted. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
as loss, the insured institution must either establish specific loss allowances
in the amount of 100% of the portion of the asset classified as loss or charge
off such amount. An asset which does not currently warrant classification but
which possesses weaknesses or deficiencies deserving close attention is required
to be designated as "special mention." Currently, general loss allowances
established to cover possible losses related to assets classified substandard or
doubtful may be included in determining an institution's regulatory capital,
while specific valuation allowances for loan losses do not qualify as regulatory
capital. See "Regulation -- Regulation of the Bank --

                                       11
<PAGE>
 
Regulatory Capital Requirements." OTS examiners may disagree with the insured
institution's classifications and amounts reserved. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS. Management of the Bank reviews assets on a quarterly
basis, and at the end of each quarter, prepares an asset classification listing
in conformity with the OTS regulations, which is reviewed by the Board of
Directors. At June 30, 1998, the Bank had $3.4 million in assets classified as
substandard. Substandard loans consisted of 13 single-family and multi-family
mortgage loans with an aggregate balance of $1.4 million at June 30, 1998, 50
consumer loans with an aggregate balance of $185,000 and six commercial loans
with an aggregate balance of $1.8 million.

         The following table sets forth an analysis of activity in the Bank's
allowance for loan losses for the periods indicated.

<TABLE> 
<CAPTION> 
                                                                      Year Ended June 30,
                                                                 ---------------------------
                                                                   1998               1997
                                                                 --------           --------
                                                                        (In thousands)
<S>                                                              <C>                <C> 
Balance at beginning of period.................................  $    306           $    180   
                                                                 --------           --------   
                                                                                               
Loans charged off:                                                                             
  Real estate mortgage loans:                                                                  
     Residential...............................................        --                  3   
     Commercial................................................        --                 --   
  Construction.................................................        --                 --   
  Commercial...................................................        --                 --   
  Consumer.....................................................       727                 97   
                                                                 --------           --------   
  Total charge-offs............................................       727                100   
                                                                 --------           --------   
                                                                                               
Recoveries:                                                                                    
  Real estate mortgage loans:                                                                  
     Residential...............................................        18                 --   
     Commercial................................................        --                 --   
  Construction.................................................        --                 --   
  Commercial...................................................        --                 --   
  Consumer.....................................................        93                 23   
                                                                 --------           --------   
  Total recoveries.............................................       111                 23   
                                                                 --------           --------   
                                                                                               
Net loans charged off..........................................       616                 77   
                                                                 --------           --------   
Provision for loan losses......................................     1,108                203   
                                                                 --------           --------   
Balance at end of period.......................................  $    798           $    306   
                                                                 ========           ========   
                                                                                               
Ratio of net charge-offs to average                                                            
   loans outstanding during the period.........................      0.51%              0.08%  
                                                                 ========           ========   
</TABLE> 

         In originating loans, the Bank recognizes that credit losses will occur
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. It is management's policy to maintain a general
allowance for loan losses based on, among other things, regular reviews of
delinquencies and loan portfolio quality, character and size, the Bank's and the
industry's historical and projected loss experience and current and forecasted
economic conditions. The Bank increases its allowance for loan losses by
charging provisions for possible losses against the Bank's income.

                                       12
<PAGE>
 
         General allowances are made pursuant to management's assessment of risk
in the Bank's loan portfolio as a whole. Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral. Management continues to actively monitor the
Bank's asset quality and to charge off loans against the allowance for loan
losses when appropriate or provide specific loan losses when necessary. As of
June 30, 1998, the Bank's allowance for loan losses included $27,000 in specific
loss reserves. Although management believes it uses the best information
available to make determinations with respect to the allowance for loan losses,
future adjustments may be necessary if economic conditions differ substantially
from the economic conditions in the assumptions used in making the initial
determinations.

         The following table allocates the Bank's allowance for loan losses by
loan category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.

<TABLE> 
<CAPTION> 
                                                                            June 30,
                                                     --------------------------------------------------------
                                                              1998                           1997
                                                     ---------------------------    -------------------------
                                                                    Percent of                     Percent of
                                                                     Loans in                       Loans in
                                                                   Category to                    Category to
                                                     Amount        Total Loans      Amount        Total Loans
                                                     ------        -----------      ------        -----------
                                                                    (Dollars in thousands)
<S>                                                  <C>           <C>              <C>           <C> 
Real estate mortgage loans.........................  $   331           41.48%       $   213           69.61%
Commercial loans...................................       --              --             --            --
Consumer loans.....................................      467           58.52             93           30.39
                                                     -------         -------        -------         -------
    Total allowance for loan losses................  $   798          100.00%       $   306          100.00%
                                                     =======          ======        =======          ======
</TABLE> 

Mortgage-Backed Securities

         The Bank maintains a significant portfolio of mortgage-backed
securities in the form of GNMA, FNMA and FHLMC participation or pass-through
certificates. GNMA certificates are guaranteed as to principal and interest by
the full faith and credit of the United States, while FNMA and FHLMC
certificates are guaranteed by that agency only. Mortgage-backed securities
generally entitle the Bank to receive a pro rata portion of the cash flows from
an identified pool of mortgages. Although mortgage-backed securities generally
yield less than the loans for which they are exchanged, they present
substantially lower credit risk and are more liquid than the individual mortgage
loans and may be used to collateralize obligations of the Bank. Because the Bank
receives regular payments of principal and interest from its mortgage-backed
securities, these investments provide more consistent cash flows than
investments in other debt securities which generally only pay principal at
maturity. Mortgage-backed securities also help the Bank meet certain
definitional tests for favorable treatment under federal banking laws. See
"Regulation -- Regulation of the Bank -- Qualified Thrift Lender Test."

         Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates within a range and have similar maturities. The underlying pool
of mortgages can be composed of either fixed-rate or ARM loans. As a result, the
interest rate risk characteristics of the underlying pool of mortgages, i.e.,
fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the
certificate holder. The life of a mortgage-backed pass-through security is equal
to the life of the underlying mortgages.

         Mortgage-backed securities, however, expose the Bank to certain unique
risks. In a declining rate environment, accelerated prepayments of loans
underlying these securities expose the Bank to the risk that it will be unable
to obtain comparable yields upon reinvestment of the proceeds. In the event the
mortgage-backed security has been funded with

                                       13
<PAGE>
 
an interest-bearing liability with a maturity comparable to the original
estimated life of the mortgage-backed security, the Bank's interest rate spread
could be adversely affected. Conversely, in a rising interest rate environment,
the Bank may experience a lower than estimated rate of repayment on the
underlying mortgages, effectively extending the estimated life of the
mortgage-backed security and exposing the Bank to the risk that it may be
required to fund the asset with a liability bearing a higher rate of interest.

         The following table sets forth the composition of the Bank's
mortgage-backed securities portfolio at the dates indicated. At June 30, 1998
and 1997, all of the Bank's mortgage-backed securities were designated as
available-for-sale and carried on the Bank's books at their fair market value.

<TABLE> 
<CAPTION> 
                                                                             At June 30,
                                                          ---------------------------------------------------
                                                                  1998                          1997
                                                          -------------------           ---------------------
                                                          Amount          %             Amount            %
                                                          ------        -----           ------          -----
                                                                           (Dollars in thousands)
    <S>                                                   <C>          <C>              <C>           <C>    
    GNMA...............................................   $   515        9.22%          $   613          9.65%
    FNMA...............................................     4,585       82.19             5,740         90.35
    FHLMC..............................................       478        8.59                --            --
                                                          -------      ------           -------        ------
                                                          $ 5,578      100.00%          $ 6,353        100.00%
                                                          =======      ======           =======        ======
</TABLE> 

         The following table sets forth the scheduled maturities, amortized
cost, market values and weighted average yields for the Bank's mortgage-backed
securities at June 30, 1998. Expected maturities will differ from contractual
maturities due to scheduled repayments and because borrowers may have the right
to call or prepay obligations with or without prepayment penalties. The
following table does not take into consideration the effects of scheduled
repayments on the effects of possible prepayments.

<TABLE> 
<CAPTION> 
                                                          At June 30, 1998
                     ---------------------------------------------------------------------------------------------
                         One to Five Years      Greater than Five Years                    Total
                     ------------------------   -------------------------   --------------------------------------
                                   Weighted                   Weighted                    Approximate     Weighted
                     Amortized      Average     Amortized      Average      Amortized        Market       Average
                        Cost         Yield         Cost         Yield          Cost           Value        Yield
                     -------------------------  -------------------------   ---------------------------------------
                                                         (Dollars in thousands)
<S>                  <C>           <C>          <C>           <C>           <C>           <C>             <C> 
GNMA..............   $      --         --%      $      515      6.11%        $     515     $     515        6.11%
FNMA..............       1,796       5.53            2,810      6.07             4,606         4,585        5.80
FHLMC.............         479       5.73               --        --               479           478        5.73
                     ---------                  ----------                   ---------     ---------
                     $   2,275                  $    3,325                   $   5,600     $   5,578
                     =========                  ==========                   =========     =========
</TABLE> 

Investment Activities

         The Bank is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the FHLB of Cincinnati, certificates of
deposit in federally insured institutions, certain bankers' acceptances, federal
funds and mutual funds which only invest in securities that are permissible
investments for the Bank. The Bank may also invest, subject to certain
limitations, in commercial paper having one of the two highest investment
ratings of a nationally recognized credit rating agency, and certain other types
of corporate debt securities and mutual funds.

         The Bank invests in investment securities in order to diversify its
assets, manage cash flow, obtain yield and maintain the minimum levels of liquid
assets required by regulatory authorities. Such investments generally include
purchases of U.S. government and agency securities, mutual funds and deposits at
other financial institutions.

                                       14
<PAGE>
 
Investment decisions are generally made by the President in accordance with a
formal investment policy adopted by the Board of Directors. The Board of
Directors ratifies all investment purchases.

         Federal regulations require the Bank to maintain an investment in FHLB
stock and a minimum amount of liquid assets which may be invested in cash and
specified securities. From time to time, the OTS adjusts the percentage of
liquid assets which savings and loan associations are required to maintain. See
"Regulation -- Regulation of the Bank -Liquidity Requirements."

         The general objectives of the Bank's investment policy are to: (i)
provide and maintain liquidity; (ii) make a strong and stable contribution to
earnings without incurring undue interest rate and credit risk; and (iii)
complement the Bank's lending activities. Currently, the Bank's investment
portfolio consists of cash, U.S. government issues, federal agency issues, FHLB
stock, mortgage-backed securities and deposits in the FHLB of Cincinnati. The
Bank also has an investment in the Franklin U.S. Government Securities Fund.
Based on information provided to the Bank by such fund, approximately 98.1% of
its assets are invested in GNMA securities, 1.4% in U.S. Treasury Bills and .5%
in cash. The present yield on such fund is 6.72%.

         The following table sets forth the carrying value of the Bank's
investment securities portfolio at the dates indicated.

<TABLE> 
<CAPTION> 
                                                                      At June 30,
                                                            ------------------------------
                                                             1998                    1997
                                                            ------                  ------
                                                                     (In thousands)
<S>                                                        <C>                    <C> 
Securities available for sale:
   U.S. government and agency securities................   $    2,485             $    3,265
   Franklin U.S. Government Securities Fund.............          920                    909
Securities held to maturity:
   U.S. government and agency securities................           --                     --
   Certificates of deposit..............................           --                     --
   Common stock and other...............................          303                    113
                                                           ----------             ----------
      Total investment securities.......................        3,708                  4,287

Cash and cash equivalents...............................        1,664                    699
FHLB stock..............................................        1,688                    724
                                                           ----------             ----------
      Total investments.................................   $    7,060             $    5,710
                                                           ==========             ==========
</TABLE> 

                                       15
<PAGE>
 
         The following table sets forth the scheduled maturities, carrying
values, market values and average yields for the Bank's investment portfolio at
June 30, 1998.

<TABLE> 
<CAPTION> 
                                     One Year or Less       One to Five Years         Five to Ten Years       More than Ten Years 
                                   --------------------   ----------------------   ----------------------   ----------------------
                                   Carrying    Average     Carrying     Average     Carrying     Average     Carrying     Average 
                                     Value      Yield        Value       Yield        Value       Yield       Value        Yield  
                                   --------   ---------   ----------   ---------   ----------   ---------   ----------   ---------
                                                                                 (Dollars in thousands)                           
<S>                                <C>        <C>        <C>           <C>         <C>          <C>         <C>          <C>      
                                                                                                                                  
Securities available for sale:                                                                                                    
   U.S. government and                                                                                                            
     agency securities......       $  1,001     2.48%      $     502     5.32%     $     496       6.01%    $     486       5.02% 
   Franklin U.S. Government                                                                                                       
     Securities Fund........             --       --             920     6.72             --         --            --         --  
                                                                                                                                  
Securities held to maturity:                                                                                                      
  Common stock and other....             --       --             303       --             --        --             --         --  
                                   --------                ---------               ---------                ---------             
      Total.................       $  1,001                $   1,725               $     496                $     486             
                                   ========                =========               =========                =========             

<CAPTION>
                                         Total Investment Portfolio      
                                     ----------------------------------   
                                      Carrying    Market      Average     
                                        Value      Value       Yield     
                                     ---------   ---------   ----------  
                                          (Dollars in thousands)                           
<S>                                 <C>          <C>         <C>                                                               
Securities available for sale:                                           
   U.S. government and                                                   
     agency securities......        $   2,485    $  2,485       4.71%        
   Franklin U.S. Government                                                 
     Securities Fund........              920         920       6.72        
                                                                            
Securities held to maturity:                                                
  Common stock and other....              303         303         --        
                                    ---------    --------                   
      Total.................        $   3,708    $  3,708                   
                                    =========    ========                    
</TABLE> 

         For further information regarding the Bank's investment securities, see
Note 2 to Notes to Consolidated Financial Statements included elsewhere herein.

                                       16
<PAGE>
 
Deposit Activities and Other Sources of Funds

         General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal repayments and interest payments and maturing
investment securities. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings may
be used to supplement the Bank's available funds and from time to time the Bank
has borrowed funds from the FHLB of Cincinnati.

         Deposits. The Bank attracts deposits from its primary market area of
Bell and Harlan Counties, Kentucky, and, to a lesser extent, Clairborne, Union
and Knox Counties Tennessee and Lee County, Virginia. A wide variety of deposit
accounts are offered, including interest-bearing and non interest-bearing
checking accounts, money market accounts, passbook and statement savings
accounts, certificates of deposit and various retirement accounts. Account terms
vary as to minimum balance requirements, maturity and interest rate.

         The Bank's policies are designed primarily to attract deposits from
local residents rather than to solicit deposits from areas outside its primary
market. Account terms, including rates, are reviewed on a periodic basis and are
compared to the terms offered for similar accounts by the Bank's competitors.
Determination of rates and other terms are based upon competitive concerns, the
returns on the Bank's various investments and projected liquidity needs.

         Certificates of deposit in amounts of $100,000 or more constituted
16.5% of the Bank's total savings portfolio at June 30, 1998. The majority of
these certificates of deposit represent deposits by individuals. The Bank does
not actively solicit these accounts from non-deposit customers and does not
offer a premium rate for such accounts.

         Savings deposits in the Bank at June 30, 1998 were represented by the
various types of savings programs described below.
<TABLE> 
<CAPTION> 
Interest       Minimum                                                     Minimum      Balances in  Percentage of
 Rate *          Term               Category                                Amount       Thousands   Total Savings
--------       -------              --------                               -------      -----------  -------------
<C>            <C>                  <S>                                   <C>           <C>          <C> 
  2.58%        None                 Passbook accounts                     $      --      $   9,157       9.37%
  1.93%        None                 NOW accounts                                100          7,688       7.87
  3.59%        None                 Money market deposit accounts             2,500            469        .48
               None                 Noninterest-bearing checking accounts       100          2,426       2.48

                                    Certificates of Deposit
                                    -----------------------

  5.762%       12-month             Fixed-term, fixed-rate                    1,000         54,085      55.35
  5.015%       2-5 year             Fixed-term, fixed-rate                    1,000         23,894      24.45
                                                                                         ---------    -------
                                                                                         $  97,719     100.00%
                                                                                         =========     ======
</TABLE> 
------------
*        Weighted average rate.

                                       17
<PAGE>
 
         Maturity of Jumbo Certificates. The following table indicates the
amount of the Bank's certificates of deposit of $100,000 or more by time
remaining until maturity as of June 30, 1998.


                                                        Certificates
         Maturity Period                                 of Deposits
         ---------------                               --------------
                                                       (In thousands)

         Three months or less.......................   $     9,027
         Over three through six months..............         1,197
         Over six through 12 months.................         2,556
         Over 12 months.............................         3,347
                                                       -----------
             Total..................................   $    16,127
                                                       ===========


         Borrowings. Savings deposits historically have been the primary source
of funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds or to meet deposit
withdrawal requirements. As a member, the Bank is required to own capital stock
in the FHLB and is authorized to apply for advances secured by such stock and by
certain of the Bank's home mortgages and other assets (principally, securities
which are obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. See "Regulation --
Regulation of the Bank -- Federal Home Loan Bank System." Advances are made
pursuant to several different programs, each of which has its own interest rate
and range of maturity.

         The following table sets forth certain information regarding the Bank's
FHLB advances (the Bank's only borrowings outstanding during the periods) at the
dates and for the periods indicated.
<TABLE> 
<CAPTION> 
                                                                       At or for the
                                                                    Year Ended June 30,
                                                            --------------------------------
                                                               1998                   1997
                                                            ----------              --------
                                                                   (Dollars in thousands)
<S>                                                        <C>                    <C> 
Advances from FHLB:
   Amounts outstanding at end of period.................   $   26,000             $   13,000

   Weighted average rate paid on........................         6.24%                  5.04%

   Maximum amount of borrowings outstanding
      at any month end..................................   $   33,500             $   14,000

   Approximate average short-term borrowings
      outstanding.......................................   $   29,750             $    9,250

   Approximate weighted average rate paid on............         6.24%                  5.04%
</TABLE> 

         The Bank has a $33.8 million line of credit with the FHLB of
Cincinnati. At June 30, 1998, the Bank had $21 million outstanding in advances
from the FHLB. These advances carry a rate of 6.45% and mature within the next
year. Further asset growth may be funded through short-term additional advances.
The Bank had $5 million outstanding that matures March 2003 bearing a rate of
6.08%.

                                       18
<PAGE>
 
Subsidiary Activities

         The Company has a subsidiary, Home Mortgage Loan Corporation ("Home").
From 1988 to June 30, 1992, Home participated in joint ventures for the purpose
of acquiring, developing, constructing and selling single family residential
real estate and held stock in the Bank's data processing provider. Home now
acquires property on its own for development. Currently, Home also makes
commercial and commercial real estate loans. At June 30, 1998, Home had total
assets of $1,550,000, including loans of $444,929.

Competition

         The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans. There
are approximately 10 commercial banks, three thrift institutions and one credit
union in Middlesboro Federal's market area. Although certain of the Bank's
competitors are subsidiaries of state-wide and interstate bank holding
companies, the Bank's primary competitors in the Middlesboro market are locally
owned and operated banks and thrifts. Because mortgage loans originated in the
Bank's primary market area are not generally saleable in the secondary market,
mortgage brokers and other non-portfolio lenders have not been significant
competitors in the Bank's immediate market area. In competing for lending
opportunities in Knox and Union Counties, the Bank encounters competition from
larger institutions operating throughout the State of Tennessee.

         The primary factors in competing for loans are interest rates, loan
fees and other terms, convenience and the range of services offered by various
financial institutions. Management seeks to compete with other institutions in
its primary market area by offering competitive interest rates, loan fees and a
wide variety of deposit products, and by emphasizing personal customer service
and cultivating relationships with local businesses. In competing for
residential mortgage loans, the Bank particularly emphasizes its quick
turn-around on applications which are processed within ten business days. The
Bank offers a high level of personal service to all of its loan customers with
loan officers who are ready to meet with customers at times and places that are
convenient to the customer.

Personnel

         As of June 30, 1998, the Bank had 37 full-time employees and three
part-time employees. The employees are not represented by a collective
bargaining unit. Management believes that the Bank enjoys good relations with
its personnel.

Performance Ratios
<TABLE> 
<CAPTION> 

                                                                            At or for the
                                                                         Year Ended June 30,
                                                                       -----------------------
                                                                        1998             1997
                                                                       ------           ------
   <S>                                                                  <C>              <C> 
   Return on assets (net income divided by average total assets).....   0.60%            0.38%
   Return on average equity (net income divided by                                       
      average stockholders' equity)..................................   8.70             8.74
   Equity to assets ratio (average equity divided by                                     
      average total assets)..........................................   6.89             4.39
</TABLE> 

                                       19
<PAGE>
 
                                   REGULATION

General

         As a federally chartered savings association, the Bank is subject to
extensive regulation by the OTS. The lending activities and other investments of
the Bank must comply with such regulatory requirements, and the OTS periodically
examines the Bank for compliance with various regulatory requirements. The FDIC
also has the authority to conduct special examinations. The Bank must file
reports with the OTS describing its activities and financial condition and is
also subject to certain reserve requirements promulgated by the Federal Reserve
Board. This supervision and regulation is intended primarily for the protection
of depositors. Certain of these regulatory requirements are referred to below or
appear elsewhere herein.

Regulation of the Bank

         Regulatory Capital Requirements. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See " -- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights and purchased credit card relationship. Both core and
tangible capital are further reduced by an amount equal to a the savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible to national banks other than subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities and
subsidiary depository institutions or their holding companies. At June 30, 1998,
the Bank had no such investments.

         Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a pro rated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require
deduction of its debt and equity investments. Adjusted total assets are reduced
by the amount of assets that have been deducted from capital, the portion of the
savings association's investments in subsidiaries that must be netted against
capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill.

         In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and the savings association's high loan-to-value ratio
land loans and non-residential construction loans and equity investments other
than those deducted from core and tangible capital. At June 30, 1998, the Bank
had no high ratio land or nonresidential construction loans and had no equity
investments for which OTS regulations require a deduction from total capital.

                                       20
<PAGE>
 
         The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios under 80% are assigned a
risk weight of 50%. Consumer and residential construction loans are assigned a
risk weight of 100%. Mortgage-backed securities issued, or fully guaranteed as
to principal and interest, by the FHLMC are assigned a 20% risk weight. Cash and
U.S. Government securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight.

         The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1998.
<TABLE> 
<CAPTION> 
                                                                                   Percent of
                                                                 Amount            Assets (1)
                                                                 ------            ----------
                                                                     (Dollars in thousands)
             <S>                                                <C>                <C> 
             Tangible capital.................................  $   8,840             6.50%
             Tangible capital requirement.....................      2,040             1.50
                                                                ---------           ------
                Excess (deficit)..............................  $   6,800             5.00%
                                                                =========           ======

             Core capital.....................................  $   8,840             6.50%
             Core capital requirement.........................      5,439             4.00
                                                                ---------           ------
                Excess (deficit)..............................  $   3,401             2.50%
                                                                =========           ======

             Risk-based capital...............................  $   9,639            10.04%
             Risk-based capital requirement...................      7,681             8.00
                                                                ---------           ------
                Excess (deficit).............................   $   1,958             2.04%
                                                                =========           ======
</TABLE> 
         ----------------
         (1)      Based on adjusted total assets for purposes of the tangible
                  capital and core capital requirements and risk-weighted assets
                  for purpose of the risk-based capital requirement.


         The OTS requires savings institutions with more than a "normal" level
of interest rate risk to maintain additional total capital. A savings
institution's interest rate risk is measured in terms of the sensitivity of its
"net portfolio value" to changes in interest rates. Net portfolio value is
defined, generally, as the present value of expected cash inflows from existing
assets and off-balance sheet contracts less the present value of expected cash
outflows from existing liabilities. A savings institution will be considered to
have a "normal" level of interest rate risk exposure if the decline in its net
portfolio value after an immediate 200 basis point increase or decrease in
market interest rates (whichever results in the greater decline) is less than
two percent of the current estimated economic value of its assets. A savings
institution with a greater than normal interest rate risk is required to deduct
from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.

         The OTS calculates the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, to be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Bank has not been
advised that it is deemed to have more than normal level of interest rate risk.

                                       21
<PAGE>
 
         In addition to requiring generally applicable capital standards for
savings institutions, the OTS is authorized to establish the minimum level of
capital for a savings institution at such amount or at such ratio of
capital-to-assets as the OTS determines to be necessary or appropriate for such
institution in light of the particular circumstances of the institution. The OTS
may treat the failure of any savings institution to maintain capital at or above
such level as an unsafe or unsound practice and may issue a directive requiring
any savings institution which fails to maintain capital at or above the minimum
level required by the OTS to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.

         Prompt Corrective Regulatory Action. Under the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking
regulators are required to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital requirements.
All institutions, regardless of their capital levels, are restricted from making
any capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that does not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below a "critical capital level," the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.

         Under implementing regulations, the federal banking regulators,
including the OTS, generally measure a depository institution's capital adequacy
on the basis of the institution's total risk-based capital ratio (the ratio of
its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the
ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio
of its core capital to adjusted total assets). Under the regulations, a savings
institution that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1
risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0%
or greater. An "adequately capitalized" savings institution is a savings
institution that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital
risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or
greater (or 3.0% or greater if the savings institution has a composite 1 CAMELS
rating). An "undercapitalized institution" is a savings institution that has:
(i) a total risk-based capital ratio less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or
3.0% if the institution has a composite 1 CAMELS rating). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next

                                       22
<PAGE>
 
lower capital category (but may not reclassify a significantly undercapitalized
institution as critically under-capitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category.

         Qualified Thrift Lender Test. A savings institution that does not meet
the Qualified Thrift Lender test ("QTL Test") must either convert to a bank
charter or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank located; (iii) the institution shall not be eligible
to obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the institution
ceases to be a Qualified Thrift Lender, it must cease any activity, and not
retain any investment not permissible for a national bank and immediately repay
any outstanding FHLB advances (subject to safety and soundness considerations).

         To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
a savings institution in its business and liquidity investments in an amount not
exceeding 20% of assets. Qualified Thrift Investments include investments in
residential mortgages, home equity loans, loans made for educational purposes,
small business loans, credit card loans and mortgage-backed securities.

         A savings institution must maintain its status as a QTL on a monthly
basis in nine out of every 12 months. A savings institution that fails to
maintain Qualified Thrift Lender status will be permitted to requalify once, and
if it fails the QTL Test a second time, it will become immediately subject to
all penalties as if all time limits on such penalties had expired. At June 30,
1998, approximately 72.7% of the Bank's assets were invested in Qualified Thrift
Investments.

         Dividend Limitations. Under OTS regulations, the Bank is not permitted
to pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of the Conversion
and Reorganization. In addition, savings institution subsidiaries of savings and
loan holding companies are required to give the OTS 30 days' prior notice of any
proposed declaration of dividends to the holding company.

         Federal regulations impose limitations on the payment of dividends and
other capital distributions (including stock repurchases and cash mergers) by
the Bank. Under these regulations, a savings institution that, immediately prior
to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted without OTS approval, after notice, to
make capital distributions during a calendar year in the amount equal to the
greater of (i) 75% of net income for the previous four quarters or (ii) up to
100% of its net income to date during the calendar year plus an amount that
would reduce by one-half the amount by which its capital-to-assets ratio
exceeded its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital requirements but not in excess of the fully
phased-in requirements (a "Tier 2 Association") is permitted, after notice, to
make capital distributions without OTS approval of up to 75% of its net income
for the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. Tier 1 Associations that have been
notified by the OTS that they are in need of more than normal supervision will
be treated as either a Tier 2 or Tier 3 Association. Unless the OTS determines
that the Bank is an institution requiring more than normal supervision, the Bank
is authorized to pay dividends in accordance with the provisions of the OTS
regulations discussed above as a Tier 1 Association.

                                       23
<PAGE>
 
         Under the OTS' prompt corrective action regulations, the Bank is also
prohibited from making any capital distributions if after making the
distribution, the Bank would have: (i) a total risk-based capital ratio of less
than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. The OTS, after consultation with the FDIC,
however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.

         In addition to the foregoing, earnings of the Bank appropriated to bad
debt reserves and deducted for Federal income tax purposes are not available for
payment of cash dividends or other distributions to stockholders without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation."

         Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. The guidelines adopted by the
OTS, along with the other federal banking agencies, require savings institutions
to maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that savings institutions should maintain
safeguards to prevent the payment of compensation, fees and benefits that are
excessive or that could lead to material financial loss, and should take into
account factors such as comparable compensation practices at comparable
institutions. If the OTS determines that a savings institution is not in
compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings institution must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Management believes that the Bank already meets substantially all the
standards adopted in the interagency guidelines, and therefore does not believe
that implementation of these regulatory standards will materially affect the
Bank's operations.

         Additionally, under FDICIA, as amended by the CDRI Act, the Federal
banking agencies are required to establish standards relating to the asset
quality and earnings that the agencies determine to be appropriate. On July 10,
1995, the federal banking agencies, including the OTS, issued proposed
guidelines relating to asset quality and earnings. Under the proposed
guidelines, a savings institution should maintain systems, commensurate with its
size and the nature and scope of its operations, to identify problem assets and
prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management believes that the asset quality and earnings standards,
in the form proposed by the banking agencies, would not have a material effect
on the Bank's operations.

         Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.

         Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's

                                       24
<PAGE>
 
financial condition and the risk posed to the deposit insurance fund. Subgroup A
consists of financially sound institutions with only a few minor weaknesses.
Subgroup B consists of institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration of the institution and
increased risk of loss to the deposit insurance fund. Subgroup C consists of
institutions that pose a substantial probability of loss to the deposit
insurance fund unless effective corrective action is taken.

         The FDIC has adopted a new assessment schedule for SAIF deposit
insurance pursuant to which the assessment rate for well-capitalized
institutions with the highest supervisory ratings would be reduced to zero and
institutions in the worst risk assessment classification will be assessed at the
rate of 0.27% of insured deposits. Until December 31, 1999, however,
SAIF-insured institutions, will be required to pay assessments to the FDIC at
the rate of 6.5 basis points to help fund interest payments on certain bonds
issued by the Financing Corporation ("FICO") an agency of the federal government
established to finance takeovers of insolvent thrifts. During this period, Bank
Insurance Fund ("BIF") members will be assessed for these obligations at the
rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF members
will be assessed at the same rate for FICO payments.

         Transactions with Affiliates. Transactions between savings institutions
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings institution is any company or entity which
controls, is controlled by or is under common control with the savings
institution. In a holding company context, the parent holding company of a
savings institution (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution. Section 106 of the BHCA which
also applies to the Bank prohibits the Bank from extending credit to or offering
any other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions.

         Loans to Directors, Executive Officers and Principal Stockholders.
Savings institutions are also subject to the restrictions contained in Section
22(h) of the Federal Reserve Act on loans to executive officers, directors and
principal stockholders. Under Section 22(h), loans to an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated entities of either, may not exceed, together with all other
outstanding loans to such person and affiliated entities the institution's loan
to one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus and an additional 10% of such capital and surplus for loans
fully secured by certain readily marketable collateral). Section 22(h) also
prohibits loans, above amounts prescribed by the appropriate federal banking
agency, to directors, executive officers and greater than 10% stockholders of a
savings institution, and their respective affiliates, unless such loan is
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. The Federal
Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section
22(h) requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons. Section 22(h) also generally prohibits a
depository institution from paying the overdrafts of any of its executive
officers or directors. Section 22(g) of the Federal Reserve Act requires that
loans to executive officers of depository institutions not be made on terms more
favorable than those afforded to other borrowers, requires approval for such
extensions of credit by the board of directors of the institution, and imposes
reporting requirements for and additional restrictions on the type, amount and

                                       25
<PAGE>
 
terms of credits to such officers. In addition, Section 106 of the BHCA
prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.

         Liquidity Requirements. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable savings deposits plus
short-term borrowings. The Bank is also required to maintain average daily
balances of short-term liquid assets at a specified percentage (currently 1%) of
the total of its net withdrawable savings accounts and borrowings payable in one
year or less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average regulatory liquidity ratio of the Bank for the month
of June 1998 was 5.99%.

         Federal Home Loan Bank System. The Bank is a member of the FHLB, which
consists of 12 Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The FHFBs provide a central credit
facility primarily for member institutions. As a member of the FHLB of
Cincinnati, the Bank is required to acquire and hold shares of capital stock in
the FHLB of Cincinnati in an amount at least equal to 1% of the aggregate unpaid
principal of its home mortgage loans, home purchase contracts, and similar
obligations at the beginning of each year, or 1/20 of its advances from the FHLB
of Cincinnati, whichever is greater. The Bank was in compliance with this
requirement with investment in FHLB of Cincinnati stock at June 30, 1998, of
$1,668,100. The FHLB of Cincinnati is funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB System. It makes advances
to members in accordance with policies and procedures established by the FHFB
and the Board of Directors of the FHLB of Cincinnati. As of June 30, 1998, the
Bank had $26 million in advances and other borrowings from the FHLB of
Cincinnati. See "Business of the Bank -- Deposit Activities and Other Sources of
Funds -- Borrowings."

         Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $47.3 million of transaction accounts, plus 10% on the remainder. This
percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a
non-interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets. As of June 30, 1998, the Bank met its reserve
requirements.

Regulation of the Company

         General. The Company is a savings and loan holding company within the
meaning of the HOLA. As such, the Company is registered with the OTS and subject
to OTS regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof. The
Company is required to file certain reports with, and otherwise comply with the
rules and regulations of the SEC under the federal securities laws.

         Activities Restrictions. The Board of Directors of the Company
presently intends to operate the Company as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and loan holding company. However, if the Director of OTS determines
that there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness, or stability of its subsidiary savings association, the
Director of OTS may impose such restrictions as deemed necessary to address such
risk including limiting: (i) payment of dividends by the savings institution,
(ii) transactions between the savings institution and its affiliates; and 
(iii) any activities of the savings institution that might create a serious risk
that the liabilities of the holding company and its affiliates may be imposed on
the savings institution. Notwithstanding the above rules as to permissible
business activities of unitary savings and loan holding companies,

                                      26
<PAGE>
 
if the savings institution subsidiary of such a holding company fails to meet
the QTL Test, then such unitary holding company shall also presently become
subject to the activities restrictions applicable to multiple holding companies
and unless the savings association requalifies as a QTL within one year
thereafter, register as, and become subject to, the restrictions applicable to a
bank holding company. See " -- Regulation of the Bank -- Qualified Thrift Lender
Test."

         If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity, upon prior notice
to, and no objection by the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv) holding
or managing properties used or occupied by a subsidiary savings institution; 
(v) acting as trustee under deeds of trust; (vi) those activities previously
directly authorized by regulation as of March 5, 1987 to be engaged in by
multiple holding companies; or (vii) those activities authorized by the Federal
Reserve Board as permissible for bank holding companies, unless the Director of
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of OTS prior to being engaged in by a multiple holding
company.

         Restrictions on Acquisitions. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (i) control of any other savings institution or savings and loan holding
company or substantially all the assets thereof, or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Except with the prior approval of the Director of OTS, no director
or officer of a savings and loan holding company or person owning or controlling
by proxy or otherwise more than 25% of such company's stock, may also acquire
control of any savings institution, other than a subsidiary savings institution,
or of any other savings and loan holding company.

         The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).

         The OTS regulations permit federal associations to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal association may not establish an out-of-state
branch unless (i) the federal association qualifies as a QTL or as a "domestic
building and loan association" under (S)7701(a)(19) of the Code and the total
assets attributable to all branches of the association in the state would
qualify such branches taken as a whole as a QTL or for treatment as a domestic
building and loan association and (ii) such branch would not result in 
(a) formation of a prohibited multi-state multiple savings and loan holding
company or (b) a violation of certain statutory restrictions on branching by
savings association subsidiaries of banking holding companies. Federal
associations generally may not establish new branches unless the association
meets or exceeds minimum regulatory capital requirements. The OTS will also
consider the association's record of compliance with the Community Reinvestment
Act of 1977 in connection with any branch application.


                                       27
<PAGE>
 
         Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings association. Pursuant to rules promulgated by the
Federal Reserve Board, owning, controlling or operating a savings institution is
a permissible activity for bank holding companies, if the savings institution
engages only in deposit-taking activities and lending and other activities that
are permissible for bank holding companies. A bank holding company that controls
a savings institution may merge or consolidate the assets and liabilities of the
savings institution with, or transfer assets and liabilities to, any subsidiary
bank which is a member of the BIF with the approval of the appropriate federal
banking agency and the Federal Reserve Board. The resulting bank will be
required to continue to pay assessments to the SAIF at the rates prescribed for
SAIF members on the deposits attributable to the merged savings institution plus
an annual growth increment. In addition, the transaction must comply with the
restrictions on interstate acquisitions of commercial banks under the BHCA.


                                    TAXATION
Federal Taxation

         The Company and the Bank file consolidated federal income tax returns.

         Thrift institutions are subject to the provisions of the Code in the
same general manner as other corporations. Prior to recent legislation,
institutions such as Middlesboro Federal which met certain definitional tests
and other conditions prescribed by the Code benefitted from certain favorable
provisions regarding their deductions from taxable income for annual additions
to their bad debt reserve. For purposes of the bad debt reserve deduction, loans
were separated into "qualifying real property loans," which generally are loans
secured by interests in certain real property, and nonqualifying loans, which
are all other loans. The bad debt reserve deduction with respect to
nonqualifying loans was based on actual loss experience, however, the amount of
the bad debt reserve deduction with respect to qualifying real property loans
could be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method"). Recently enacted legislation repealed
the percentage of taxable income method of calculating the bad debt reserve.
Middlesboro Federal historically has elected to use the experience method.

         Earnings appropriated to an institution's bad debt reserve and claimed
as a tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.

         Beginning with the first taxable year beginning after December 31,
1995, savings institutions, such as the Bank, will be treated the same as
commercial banks. Institutions with $500 million or more in assets will only be
able to take a tax deduction when a loan is actually charged off. Institutions
with less than $500 million in assets will still be permitted to make deductible
bad debt additions to reserves, but only using the experience method.

         Neither the Company's nor Middlesboro Federal's federal corporate
income tax returns have been audited in the last five years.

State Income Taxation

         The Commonwealth of Kentucky imposes an annual franchise tax on
financial institutions regularly engaged in business in Kentucky at any time
during the calendar year. This tax is 1.1% of Middlesboro Federal's net capital.
For purposes of this tax, net capital is defined as the aggregate of the Bank's
capital stock, paid-in capital, retained earnings and net unrealized gains or
losses on securities designated as available-for-sale less an amount equal to
the five year average of the percentage that the book value of any United States
obligations held by the Bank bears to the book value of the Bank's total assets.
Financial institutions which are subject to tax both within and without Kentucky
must apportion their net capital. For the year ended June 30, 1998, the amount
of such expense for Middlesboro Federal was $85,753.

                                       28
<PAGE>
 
Item 2.  Description of Property
--------------------------------

         The following table sets forth the location and certain additional
information regarding the Bank's offices and other material property.

<TABLE> 
<CAPTION> 


                                                              Book Value at                        Deposits at
                            Year          Owned or              June 30,         Approximate        June 30,
                           Opened          Leased                 1998         Square Footage         1998
                           ------          ------            --------------    --------------       ---------
<S>                        <C>             <C>               <C>               <C>                 <C>      
                                                         (Dollars in thousands)
Main Office:

1431 Cumberland Avenue
Middlesboro, Kentucky       1915            Owned              $  1,389             11,906         $  61,487

Branch Offices:

1501 E. Main Street
Cumberland, Kentucky        1976           Leased                   173              1,700            29,194

134 Pine Street
Pineville, Kentucky         1997           Leased                   133                750             7,038

</TABLE> 

         The Bank recently expanded its main office by constructing an addition
which increased its square footage by 6,000 square feet. The addition was
completed in January 1997 and is used to house the Bank's administrative
offices. The Bank is in the process of constructing a new branch office in
Fountain City, Tennessee. The cost to date is $806,507. The expected completion
date is the Fall of 1998.

Item 3. Legal Proceedings.
-------------------------

         Although the Bank, from time to time, is involved in various legal
proceedings in the normal course of business, there are no material legal
proceedings to which the Company, the Bank or its subsidiary is a party or to
which their property is subject.

Item 4.  Submission of Matters to Vote of Security-Holders.
----------------------------------------------------------

         No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 1998.

                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters
-----------------------------------------------------------------

         The Company's common stock, par value $.01 per share (the "Common
Stock"), is traded on the over-the-counter market with quotations available
through the OTC "Electronic Bulletin Board" under the symbol "CMBN." Trading
commenced in April 1997. The high and low stock price by quarter since the
inception of trading through fiscal year 1998 were as follows:

                Quarter Ended                     High            Low
                -------------                     ----            --- 

                June 30, 1997                    $14.00        $ 10.00
                September 30, 1997                14.25          14.00
                December 31, 1997                 15.25          14.25
                March 31, 1998                   16.875          15.25
                June 30, 1998                    16.875          15.75

                                       29
<PAGE>
 
         No dividends have been declared during this period. As of September 8,
1998, there were 157 recordholders of the Common Stock.

         Payment of dividends by the Company is subject to determination and
declaration by the Board of Directors in accordance with applicable statutory
requirements. Payment of dividends by the Company also depends on the receipt of
dividends from the Bank, which is subject to regulatory restrictions on the
payment of dividends.


Item 6.  Management's Discussion and Analysis or Plan of Operation
------------------------------------------------------------------

General

         The Company's principal business is that of the Bank. Therefore, this
discussion relates primarily to the Bank.

         Middlesboro Federal is primarily engaged in attracting deposits from
the general public and using those and other available sources of funds to
originate loans secured by properties located in Bell and Harlan Counties in
southeastern Kentucky, Clairborne, Knox and Union Counties in upper east
Tennessee and western Lee County in Virginia. To a lesser extent, Middlesboro
Federal also originates construction loans, multi-family and commercial real
estate loans, commercial business loans and consumer loans. It also has a
significant amount of investments in mortgage-backed securities and United
States Government and federal agency obligations.

         The profitability of Middlesboro Federal depends primarily on its net
interest income, which is the difference between interest and dividend income on
its interest-earning assets, principally loans, mortgage-backed securities and
investment securities, and interest expense on its interest-bearing deposits and
borrowings. Middlesboro Federal's net earnings also are dependent, to a lesser
extent, on the level of its noninterest income (including servicing fees and
other fees) and its noninterest expenses, such as compensation and benefits,
occupancy and equipment, insurance premiums, and miscellaneous other expenses,
as well as federal income tax expense.

Year 2000

         Like most financial institutions, the Company's principal subsidiary
relies extensively on computers in conducting its business. It has been widely
reported that many computer programs currently in use were designed without
adequately considering the impact of the upcoming change in century on their
date codes. If these design flaws are not corrected, these computer applications
may malfunction in the year 2000. Subsequent to fiscal year end, the Company
converted its mission-critical processing systems to a new system which is Year
2000 compliant and is fully tested and fully certified. The Company expects to
complete testing of systems provided by third party providers by December 31,
1998. It estimates that the additional costs associated with resolving all Year
2000 problems (other than the costs associated with the new processing system)
will not exceed $100,000. Since the decision to convert to a new processing
system was not related to Year 2000 compliance, the costs of such system
(approximately $325,000) will be capitalized.

Asset and Liability Management

         The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate-sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap," provides
an indication of the extent to which an institution's interest rate spread will
be affected by changes in interest rates. A gap is considered positive when the
amount of interest rate-sensitive assets exceeds the amount of interest
rate-sensitive liabilities, and is considered negative when the amount of
interest rate-sensitive liabilities exceeds the amount of interest
rate-sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would adversely affect

                                       30
<PAGE>
 
net interest income, while a positive gap within shorter maturities would result
in an increase in net interest income, and during a period of falling interest
rates, a negative gap within shorter maturities would result in an increase in
net interest income while a positive gap within shorter maturities would have
the opposite effect.

         Net Portfolio Value. In recent years, the Bank has measured its
interest rate sensitivity by computing the "gap" between the assets and
liabilities which were expected to mature or reprice within certain periods,
based on assumptions regarding loan prepayment and deposit decay rates formerly
provided by the OTS. However, the OTS now requires the computation of amounts by
which the net present value of an institution's cash flows from assets,
liabilities and off balance sheet items (the institution's net portfolio value,
or "NPV") would change in the event of a range of assumed changes in market
interest rates. The OTS also requires the computation of estimated changes in
net interest income over a four-quarter period. These computations estimate the
effect of an institution's NPV and net interest income of instantaneous and
permanent 1% to 4% increases and decreases in market interest rates.

         The following table sets forth the interest rate sensitivity of the
Bank's net portfolio value as of June 30, 1998 in the event of 1%, 2%, 3% and 4%
instantaneous and permanent increases and decreases in market interest rates,
respectively. These changes are set forth below as basis points, where 100 basis
points equals one percentage point.

<TABLE> 
<CAPTION> 


       Change                          Net Portfolio Value                      NPV as % of Portfolio Value of Assets
                          ---------------------------------------               -------------------------------------
      in Rates            $ Amount        $ Change       % Change               NPV Ratio          Basis Point Change
      --------            --------        --------       --------               ---------         -------------------
                                             (Dollars in thousands)
<S>                       <C>             <C>            <C>                    <C>               <C>    

      + 400   bp             5,922         (4,569)           (44)%                 4.63%              (310) bp
      + 300   bp             7,426         (3,065)           (29)                  5.71               (203) bp
      + 200   bp             8,762         (1,729)           (16)                  6.63               (111) bp
      + 100   bp             9,828           (662)            (6)                  7.33                (41) bp
          0   bp            10,490                                                 7.73
      - 100   bp            10,983            492              5                   8.02                 28  bp
      - 200   bp            11,479            989              9                   8.29                 56  bp
      - 300   bp            12,288          1,798             17                   8.77                103  bp
      - 400   bp            13,202          2,712             26                   9.29                156  bp
</TABLE> 

         The following table sets forth the interest rate risk capital component
for the Bank at June 30, 1998 given a hypothetical 200 basis point rate change
in market interest rates.

<TABLE> 
<CAPTION> 

                                                                                         At
                                                                                   June 30, 1998
                                                                                   -------------     
<S>                                                                                <C> 
Pre-shock NPV Ratio: NPV as % of Portfolio Value of Assets...................           7.73%

Exposure Measure: Post-Shock NPV Ratio.......................................           6.63%

Sensitivity Measure: Change in NPV Ratio.....................................            111  bp

</TABLE> 

         Computations of prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including relative levels of market
interest rates, loan prepayments and deposit run-offs, and should not be relied
upon as indicative of actual results. Further, the computations do not
contemplate any actions the Bank may undertake in response to changes in
interest rates.


                                       31
<PAGE>
 
         Certain shortcomings are inherent in the method of analysis presented
in both the computation of NPV and in the analysis presented in prior tables
setting forth the maturing and repricing of interest-earning assets and
interest-bearing liabilities. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in differing degrees to changes in market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable-rate
loans, which represent the Bank's primary loan product, have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In addition, the proportion of adjustable-rate loans in the
Association's portfolios could decrease in future periods if market interest
rates remain at or decrease below current levels due to refinance activity.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in the
tables. Finally, the ability of many borrowers to service their adjustable-rate
debt may decrease in the event of an interest rate increase.

         The lending activities of savings institutions have historically
emphasized long-term, fixed-rate loans secured by single-family residences, and
the primary source of funds of such institutions has been deposits. The deposit
accounts of savings associations generally bear interest rates that reflect
market rates and largely mature or are subject to repricing within a short
period of time. This factor, in combination with substantial investments in
long-term, fixed-rate loans, has historically caused the income earned by
savings associations on their loan portfolios to adjust more slowly to changes
in interest rates than their cost of funds.

         Middlesboro Federal originates both fixed- and adjustable-rate
residential real estate loans as market conditions dictate. Prior to the 1980s,
Middlesboro Federal, like virtually all savings associations, originated only
fixed-rate loans and held them in portfolio until maturity. As a result of the
problems caused by holding fixed-rate loans in a rapidly increasing
interest-rate environment, changes in regulations to allow for variable-rate
loans and consumer demand for such loans during periods of high interest rates,
Middlesboro Federal began to transform its portfolio into loan products the
interest rates of which adjust periodically. As a result, 60.8% of Middlesboro
Federal's loan portfolio, as of June 30, 1998 consisted of adjustable or
floating rate loans.

         Notwithstanding the foregoing, however, because Middlesboro Federal's
interest-bearing liabilities which mature or reprice within short periods
substantially exceed its earning assets with similar characteristics, material
and prolonged increases in interest rates generally would adversely affect net
interest income, while material and prolonged decreases in interest rates
generally, but to a lesser extent because of their historically low levels,
would have the opposite effect.


                                       32
<PAGE>
 
Average Balances, Interest and Average Yields

         The following table sets forth certain information relating to the
Company's average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balance of assets
or liabilities, respectively, for the periods presented. Average balances for
loans include nonaccrual loans. Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances instead
of daily balances has caused any material difference in the information
presented.

<TABLE> 
<CAPTION> 

                                                                                Year Ended June 30,
                                                   ---------------------------------------------------------------------------
                                                                 1998                                      1997
                                                   ---------------------------------       -----------------------------------
                                                   Average                   Average       Average                     Average
                                                   Balance      Interest      Rate         Balance       Interest       Rate
                                                   -------      --------      ----         -------       --------       ----
                                                                                (Dollars in thousands)
<S>                                               <C>          <C>          <C>           <C>          <C>          <C> 
INTEREST INCOME                              
  Loans                                      
    Consumer....................................   $ 19,454     $   1,956    10.05%        $  12,470     $ 1,208       9.69%
    Other.......................................      8,866           875     9.87             3,749         270       7.20
    Mortgage....................................     90,849         7,241     7.97            74,710       5,096       6.82
                                                   --------     ---------                  ---------     -------
    Total loans.................................    119,169        10,072     8.45            94,642       6,574       6.95
                                                   --------     ---------                  ---------     -------
  Mortgage-backed securities....................      5,686           355     6.24             7,357         435       5.91
  Investment securities.........................      3,399           215     6.33             3,352         240       7.16
  FHLB stock....................................      1,659           108     6.51               580          41       7.07
                                                   --------     ---------                  ---------     -------
  Total interest-earning assets.................    129,913        10,750     8.27           105,931       7,290       6.88
                                                                ---------                                -------
  Non-interest-earning assets...................      6,802                                      589
                                                   --------                                ---------
    Total assets................................   $136,715                                $ 106,520
                                                   ========                                =========
                                             
INTEREST EXPENSE                             
  Savings deposits..............................   $  9,215     $     244     2.65%        $   9,592     $   250       2.61%
  Certificates of deposit.......................     77,510         4,206     5.43            72,042       3,380       4.69
  Demand, NOW and money market..................     11,145           227     2.04            10,121         217       2.14
                                                   --------     ---------                  ---------     -------
       Total deposits...........................     97,870         4,677     4.78            91,755       3,847       4.19
  Funds borrowed................................     21,446         1,611     7.51             9,250         466       5.04
                                                   --------     ---------                  ---------     -------
Total interest-bearing liabilities..............    119,316         6,288     5.27           101,005       4,313       4.27
                                                                ---------                                -------
Other non-interest-bearing liabilities..........      8,162                                      836
Total stockholders' equity......................      9,237                                    4,679
                                                   --------                                ---------
    Total liabilities and stockholders' equity..    136,715                                $ 106,520
                                                   ========                                =========
                                             
Net interest income.............................                $   4,462                                $ 2,977
                                                                =========                                =======
Interest rate spread............................                              3.00%                                    2.61%
                                                                             =====                                    =====
Net yield on interest-earning assets............                              3.43%                                    2.81%
                                                                             =====                                    =====
Ratio of average interest-earning assets to  
  average interest-bearing liabilities..........     108.88%                               104.88 %
                                                   ========                                =======
</TABLE> 

                                       33
<PAGE>
 
Rate/Volume Analysis

         The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rate (change in
rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) have been allocated proportionately between
changes in rate and changes in volume at the basis of the absolute values of
changes in rate and changes in volume.

<TABLE> 
<CAPTION> 

                                                               Year Ended June 30,
                                         -----------------------------------------------------------------
                                           1998       vs.       1997        1997         vs.       1996
                                         -----------------------------     -------------------------------             
                                              Increase (Decrease)                Increase (Decrease)
                                                    Due to                             Due to
                                         -----------------------------     -------------------------------             

                                         Rate        Volume      Total      Rate        Volume      Total
                                         ----        ------      -----      ----        ------      -----
                                                                   (In thousands)
<S>                                    <C>         <C>        <C>         <C>         <C>         <C> 
Interest Income:
  Loans:
    Consumer..........................  $     71    $    677   $    748     $    (51)   $    731    $    680
    Other.............................       237         368        605          (24)        100          76
    Mortgage..........................     1,044       1,101      2,145          158       1,511       1,669
  Mortgage-backed securities..........        19         (99)       (80)         (18)       (182)       (200)
  Investment securities...............       (28)          3        (25)          42        (191)       (149)
  FHLB stock..........................        (9)         76         67            2          10          12
                                        --------    --------   --------     --------    --------    --------
      Total interest income...........     1,334       2,126      3,460          109       1,979       2,088
                                        --------    --------   --------     --------    --------    --------

Interest expense
  Savings deposits....................         4         (10)        (6)         (31)         11         (20)
  Certificates of deposit.............       570         256        826         (495)      1,039         544
  Demand, NOW and money market........       (12)         22         10           (4)         19          15
  Funds borrowed......................       530         615      1,145            4         453         457
                                        --------    --------   --------     --------    --------    --------
      Total interest expense..........     1,092         883      1,975         (526)      1,522         996
                                        --------    --------   --------     --------    --------    --------

Change in net interest income.........  $    242    $  1,243   $  1,485     $    635    $    457    $  1,092
                                        ========    ========   ========     ========    ========    ========
</TABLE> 


Comparison of Financial Condition at June 30, 1998 and 1997

         The Company's total assets increased by $21.2 million, or 18.53%, from
$114.6 million at June 30, 1997 to $135.9 million at June 30, 1998. The increase
in assets was principally due to an $18.4 million, or 18.51%, increase in the
Bank's loan portfolio, as well as a $1.2 million, or 58.82%, increase in
premises and equipment and a $964,000, or 133.03%, increase in FHLB Stock. These
increases were partially offset by decreases of $776,000, or 18.60%, in
investment securities and $775,000, or 12.20%, in mortgage-backed securities
designated as available-for-sale.

         The growth in the Bank's loan portfolio during fiscal year 1998
reflects the Bank's continued focus on loan originations. Although increased
originations of one- to four-family mortgages accounted for the most significant
portion of the total increase in the loan portfolio, the Bank experienced growth
in all categories of loans.

         The reduction in investment securities was due to maturities of
securities that was reinvested in higher yielding loans. The decline in the
balance of mortgage-backed securities classified as available-for-sale reflects
principal repayments on the securities.

                                       34
<PAGE>
 
         Total liabilities amounted to $127.1 million at June 30, 1998, up from
$106.1 million at June 30, 1997. The $21.0 million increase was attributable to
a $13.0 million, or 100.0 %, increase in FHLB advances, a $6.1 million, or
6.68%, increase in deposits and a $1.0 million, or 144.58%, increase in notes
payable. The increased level of liabilities was used to fund asset growth during
the year.

         Total stockholders' equity increased by $247,000 from $8.5 million at
June 30, 1997 to $8.8 million at June 30, 1998. This increase was due primarily
to the retention of net income of $751,000 from the period, partially offset by
additional purchases of shares by the ESOP which are an offset to stockholders'
equity.

Comparison of Results of Operations for the Years Ended June 30, 1998 and 1997

         Net Income. Net income for the year ended June 30, 1998 increased by
$342,000, or 83.73%, to $751,000 from $409,000 for the year ended June 30, 1997.
The increase was due to the combined effects of an improved net interest margin,
higher non-interest income resulting primarily from loan fee income. These
improvements were partially offset by an increase in interest expense, provision
for loan loss and noninterest expense.

         Net Interest Income. Net interest income increased by $1.5 million from
$3.0 million for the year ended June 30, 1997 to $4.5 million for the year ended
June 30, 1998. The Bank's interest rate spread widened by 39 basis points from
2.61% in fiscal year 1997 to 3.00% in fiscal year 1998 due primarily to the
$24.0 million, or 22.64%, increase in interest earning assets. The ratio of
average interest earning assets to average interest-bearing liabilities
increased from 104.88% for fiscal year 1997 to 108.88% for fiscal year 1998.

         Interest Income. Interest income totaled $10.7 million for the year
ended June 30, 1998, an increase of $3.5 million, or 47.45%, from fiscal year
1997's level of $7.3 million. The increase resulted from a $24.5 million, or
25.2%, increase in the average balance of loans outstanding from $94.6 million
for fiscal year 1997 to $119.1 million for fiscal year 1998. Mortgage loan
growth accounted for the most significant portion of the total growth. Average
mortgage loans outstanding rose from $74.7 million for fiscal year 1997 to $90.8
million for fiscal year 1998 and reflected the Bank's continued emphasis on loan
originations during fiscal year 1998. The average balance of consumer loans also
increased year to year from $12.5 million for fiscal year 1997 to $19.5 million
for fiscal year 1998. Interest income from investment and mortgage-backed
securities declined by $104,000, or 15.45%, from $674,000 for fiscal year 1997
to $570,000 for fiscal year 1998 due mainly to a decrease in the average balance
of such securities of $1.6 million, combined with a 50 basis point decrease in
the average yield on such securities. The decreased level of the Bank's
investment and mortgage-backed securities reflects the Bank's strategy of
emphasizing loan originations over investment purchases.

         Interest Expense. Total interest expense increased by $2.0 million, or
45.80%, due primarily to an increase in the average balance of short term
borrowings from the FHLB from $9.3 million in fiscal year 1997 to $21.4 million
for fiscal year 1998 as well as an increase in the average rate paid on the
Bank's certificates of deposit and, to a lesser degree, with an increase in the
average balance of such certificates during the period. The increased level of
short term borrowings during fiscal year 1998 was necessitated by the high
demand for loans during the period. The average rate paid on the Bank's
certificates of deposit for the year ended June 30, 1998 was 5.43%, an increase
of 74 basis points from an average cost of 4.69% for the year ended June 30,
1997. The average balance of the Bank's certificates of deposit rose by $5.5
million to $77.5 million for fiscal year 1998 as compared to $72.0 million for
fiscal year 1997. Overall, the average cost of interest-bearing liabilities
increased by 100 basis points to 5.27% for the year ended June 30, 1998 as
compared to fiscal year 1997's level of 4.27% as the increase in the cost of
FHLB borrowings and certificates of deposit was partially offset by a 10 basis
point decrease in the average rate paid on NOW and Money Market accounts.

         Provision for Loan Losses. The provision for loan losses increased by
$905,000, or 445.12% from $203,000 for the year ended June 30, 1997 to $1.1
million for the year ended June 30, 1998. The increased provision was deemed
necessary by the Bank due to the growth in the Bank's loan portfolio, the
increased level of nonperforming assets and

                                       35
<PAGE>
 
the increased risk profile of the loan portfolio due to the growth in consumer
and commercial real estate lending during fiscal year 1998. The allowance for
loan losses as a percentage of gross loans at fiscal year end 1998 was .67% as
compared to .31% at fiscal year end 1997.

         Noninterest Income. Noninterest income totaled $1.1 million for the
year ended June 30, 1998, an increase of $394,000, or 54.44%, from $723,000 for
the year ended June 30, 1997. During fiscal year 1998, the Bank realized a net
gain of $113,000 from the sale of investment securities as compared to a net
gain of $50,000 from the sale of investment securities during fiscal year 1997.
In addition, due to the increased level of loan originations during the period,
loan fees and other service charges rose by $213,000, or 32.38%, to a total of
$870,000 for the year ended June 30, 1998 as compared to $657,000 for the year
ended June 30, 1997.

         Noninterest Expense. Noninterest expense increased $450,000 or 15.53%,
from $2.9 million for the year ended June 30, 1997 to $3.3 million for the year
ended June 30, 1998. Salaries and employee benefit expenses rose by $170,000, or
14.34%, from $1.2 million for fiscal year 1997 to $1.4 million for fiscal year
1998. The increase was primarily attributable to normal salary increases coupled
with an increase in the Bank's staffing levels. Other expenses, consisting
mainly of advertising, increased by $220.000, or 30.51%, from $720,000 for
fiscal year 1997 to $939,000 for fiscal year 1998. Deposits insurance premiums
amounted to $68,000 for fiscal year 1998 as compared to $479,000 for fiscal year
1997. The $411,000 decrease was primarily attributable to the absence of any
SAIF special assessment during the 1998 fiscal year. During fiscal year 1997,
all institutions with deposits insured by the SAIF were required to pay a
special assessment to recapitalize the SAIF. This assessment, which was
calculated based upon total deposits at March 31, 1995, amounted to $388,000 for
the Bank.

         Income Tax Expense. Income tax expense increased by $180,000 from
$190,000 for fiscal year 1997 to $370,000 for fiscal year 1998. The increase in
income tax expense is due directly to the increased level of earnings during
fiscal year 1998. The effective tax rates for fiscal years 1998 and 1997 were
33% and 31.7%, respectively. The variations in the effective tax rate are
attributable to the composition of the income base, the amount of tax exempt
income and timing differences related to the deferred compensation arrangements.

Comparison of Results of Operations for the Years Ended June 30, 1997 and 1996

         Net Income. Net income for the year ended June 30, 1997 increased by
$263,000, or 180.69%, to $409,000 from $146,000 for the year ended June 30,
1996. The increase was due to the combined effects of an improved net interest
margin and higher non-interest income resulting primarily from loan fee income.
These improvements were partially offset by the combined effects of a one time
charge of $152,000 to record the funding of a director retirement plan and the
special assessment on deposits insured by the SAIF of $388,000 which was paid
during the second quarter of fiscal year 1997.

         Net Interest Income. Net interest income increased by $1.1 million from
$1.9 million for the year ended June 30, 1996 to $3 million for the year ended
June 30, 1997. The Bank's interest rate spread widened by 66 basis points from
1.95% in fiscal year 1996 to 2.61% in fiscal year 1997 due primarily to the
$29.2 million increase in interest earning assets. The ratio of average interest
earning assets to average interest-bearing liabilities decreased from 110.99%
for fiscal year 1996 to 104.88% for fiscal year 1997.

         Interest Income. Interest income totaled $7.3 million for the year
ended June 30, 1997, an increase of $2.1 million, or 40.4%, from fiscal year
1996's level of $5.2 million. The increase resulted from a $34.8 million, or
58.2%, increase in the average balance of loans outstanding from $59.8 million
for fiscal year 1996 to $94.6 million for fiscal year 1997. Mortgage loan growth
accounted for the most significant portion of the total growth. Average mortgage
loans outstanding rose from $52.6 million for fiscal year 1996 to $74.7 million
for fiscal year 1997 and reflected the Bank's increased emphasis on loan
originations during fiscal year 1997. The average balance of consumer loans also
increased year to year from $4.9 million for fiscal year 1996 to $12.5 million
for fiscal year 1997. Interest income from investment and mortgage-backed
securities declined by $326,000, or 31.8%, from $1.0 million for fiscal year
1996 to

                                       36
<PAGE>
 
$674,000 for fiscal year 1997 due mainly to a decrease in the average balance of
such securities of $5.8 million, offset in part by a 53 basis point increase in
the average yield on such securities. The decreased level of the Bank's
investment and mortgage-backed securities reflects the Bank's strategy of
emphasizing loan originations over investment purchases.

         Interest Expense. Total interest expense increased by $996,000, or
30.0%, due primarily to an increase in the average balance of short term
borrowings from the FHLB from $264,000 in fiscal year 1996 to $9.2 million for
fiscal year 1997 as well as an increase average rate paid on the Bank's
certificates of deposit and, to a lesser degree, with an increase in the average
balance of such certificates during the period. The increased level of short
term borrowings during fiscal year 1997 was necessitated by the high demand for
loans during the period. The average rate paid on the Bank's certificates of
deposit for the year ended June 30, 1997 was 4.69%, a decrease of 99 basis
points from an average cost of 5.68% for the year ended June 30, 1996. The
average balance of the Bank's certificates of deposit rose by $22.0 million to
$72.0 million for fiscal year 1997 as compared to $50.0 million for fiscal year
1996. Overall, the average cost of interest-bearing liabilities decreased by 56
basis points to 4.27% for the year ended June 30, 1997 as compared to fiscal
year 1996's level of 4.83% as the increase in the cost of FHLB borrowings and
certificates of deposit was partially offset by a 38 basis point decrease in the
average rate paid on NOW and Money Market accounts.

         Provision for Loan Losses. The provision for loan losses increased by
$145,000, or 250%, from $58,000 for the year ended June 30, 1996 to $203,000 for
the year ended June 30, 1997. The increased provision was deemed necessary by
the Bank due to the growth in the Bank's loan portfolio and the increased risk
profile of the loan portfolio due to the growth in consumer and commercial real
estate lending during fiscal year 1997. The allowance for loan losses as a
percentage of gross loans at fiscal year end 1997 was 0.20% as compared to 0.30%
at fiscal year end 1996.

         Noninterest Income. Noninterest income totaled $723,000 for the year
ended June 30, 1997, an increase of $411,000, or 131.7%, from $312,000 for the
year ended June 30, 1996. During fiscal year 1997, the Bank realized a net gain
of $50,000 from the sale of investment securities as compared to a net gain of
$20,000 from the sale of investment securities during fiscal year 1996. In
addition, due to the increased level of loan originations during the period,
loan fees and other service charges rose by $385,000, or 141.5%, to a total of
$657,000 for the year ended June 30, 1997 as compared to $272,000 for the year
ended June 30, 1996.

         Noninterest Expense. Noninterest expense increased $1.0 million, or
52.6%, from $1.9 million for the year ended June 30, 1996 to $2.9 million for
the year ended June 30, 1997. Salaries and employee benefit expenses rose by
$211,000, or 21.6%, from $975,000 for fiscal year 1996 to $1.2 million for
fiscal year 1997. The increase was primarily attributable to a one-time expense
of $152,000 which was incurred to fund a director retirement plan. The remaining
portion of the increase reflects normal salary increases coupled with an
increase in the Bank's staffing levels. Other expenses increased by $808,000, or
89.3%, from $905,000 for fiscal year 1996 to $1.7 million for fiscal year 1997.
This increase was primarily attributable to the special SAIF assessment of
$388,000.

         Income Tax Expense. Income tax expense increased by $76,000 from
$113,000 for fiscal year 1996 to $189,000 for fiscal year 1997. The increase in
income tax expense is due directly to the increased level of earnings during
fiscal year 1997. The effective tax rates for fiscal years 1997 and 1996 were
31.7% and 43.6%, respectively. The variations in the effective tax rate are
attributable to the composition of the income base, the amount of tax exempt
income and timing differences related to the deferred compensation arrangements.

Liquidity and Capital Resources

         The Company currently has no business other than that of the Bank. The
Company's assets consist almost entirely of its investments in the Bank. To fund
any future dividend payments by the Company or to provide funds for activities
at the Company level, the Company would be dependent upon dividends from the
Bank. The Bank is subject to certain regulatory limitations with respect to
certain regulatory limitations with respect to the payment of dividends to the
Company. At June 30, 1998, the Bank had approximately $750,000 available for the
payment of dividends by the Bank to the Company under these regulations.

                                       37
<PAGE>
 
         The Bank is required by OTS regulations to maintain minimum levels of
specified liquid assets which are currently equal to 4% of deposits and
short-term borrowings. The Bank's average liquidity ratio was 5.99% at June 30,
1998.

         The Bank's principal sources of funds for investments and operations
are net income, deposits from its primary market area, principal and interest
payments on loans and mortgage-backed securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered a primary source of funds supporting the Bank's lending and
investment activities. Deposits were $97.7 million and $91.6 million at June 30,
1998 and 1997, respectively.

         The Bank's most liquid assets are cash and cash equivalents, which are
cash on hand, amounts due from financial institutions, federal funds sold,
certificates of deposit with other financial institutions that have an original
maturity of three months or less and money market mutual funds. The levels of
such assets are dependent on the Bank's operating, financing and investment
activities at any given time. The Bank's cash and cash equivalents totaled $1.7
million and $699,000 at June 30, 1998 and 1997, respectively. The variations in
levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.

         At June 30, 1998, Middlesboro Federal had $1.6 million in commitments
to originate loans. At June 30, 1998, the Bank had $55.7 million in certificates
of deposit which were scheduled to mature in one year or less. It is anticipated
that the majority of these certificates will be renewed in the normal course of
operations.

         Middlesboro Federal is not aware of any trends or uncertainties that
will have or are reasonably expected to have a material effect on the Bank's
liquidity or capital resources. The Bank has no current plans for material
capital improvements or other capital expenditures that would require more funds
than are currently on hand.

Accounting Pronouncements

         Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities. The FASB has issued SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities",
which is effective for the Company's fiscal year beginning July 1, 1997. SFAS
125 provides standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. The impact of the adoption of
SFAS 125 upon the results of operations of the Company was not material.

         Accounting for Impairment of Loans. The Company's measurement of
impaired loans includes those loans which are performing according to all
contractual terms of the loan agreement but may have substantive indication of
potential credit weakness. As of June 30, 1998, $1.7 million of loans were
considered impaired by the Company and carried on a non-accrual basis. These
loans were measured for impairment using the fair value of collateral or using
the present value of the expected future cash flows discounted at the loan's
effective rate. If as a result of these measurements, any loans required
valuation allowances, they were included within the overall allowance for loan
losses at June 30, 1998. Residential mortgages and consumer loans and leases
outside the scope of SFAS 114 are collectively evaluated for impairment.

         Accounting for Impairment of Long-Lived Assets. The FASB issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," which was effective for the Company's fiscal year
beginning July 1, 1996. SFAS No. 121 requires that long-lived assets and certain
identifiable intangibles to be held and used be reviewed for impairment whenever
events or changes in circumstances indicate the carrying amount of an asset may
not be recoverable. If the sum of the expected future cash flows from the use of
the asset and its eventual disposition is less than the carrying amount of the
asset, an impairment loss is recognized. SFAS No. 121 also requires that certain
assets to be disposed of be measured at the lower of carrying amount or the net
realizable value. The impact of adopting SFAS 121 upon the results of operations
of the Company was not material.


                                       38
<PAGE>
 
         Stock-Based Compensation Plans. The Company accounts for its
stock-based compensation plans under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). Effective in 1996, the
Company adopted the disclosure option of SFAS No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123), which requires that companies not electing
to account for stock-based compensation as prescribed by the statement, disclose
the pro forma effects on earnings and earnings per share as if SFAS 123 had been
adopted. Additionally, certain other disclosures are required with respect to
stock compensation and the assumptions used to determine the pro forma effects
of SFAS 123.

Impact of Inflation and Changing Prices

         The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation.

         Unlike most companies, the assets and liabilities of a financial
institution are primarily monetary in nature. As a result, interest rates have a
more significant impact on a financial institution's performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the price of goods and
services, since such prices are affected by inflation. In the current interest
rate environment, liquidity and the maturity structure of the Company's assets
and liabilities are critical to the maintenance of acceptable performance
levels.

                                       39
<PAGE>
 
Item 7.  Financial Statements
-----------------------------

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE> 
<CAPTION> 
                                                                                                              Page
                                                                                                              ----
<S>                                                                                                          <C>    
         Independent Auditor's Opinion.......................................................................  41
                                                                                                               
         Consolidated Balance Sheets                                                                           
         as of June 30, 1998, 1997 and 1996..................................................................  42
                                                                                                               
         Consolidated Statements of Income                                                                     
         for the Years Ended June 30, 1998, 1997 and 1996....................................................  44
                                                                                                               
         Consolidated Statements of Stockholders' Equity                                                       
         for the Years Ended June 30, 1998, 1997 and 1996....................................................  46
                                                                                                               
         Consolidated Statements of Cash Flows                                                                 
         for the Years Ended June 30, 1998, 1997 and 1996....................................................  48
                                                                                                               
         Notes to the Consolidated Financial Statements......................................................  50
</TABLE> 

                                       40
<PAGE>
 
Marr, Miller & Myers, PSC
--------------------------------------------------------------------------------
Certified Public Accountants                              P.O. Box 663
(606)  528-2454 (FAX 528-1770)                            Corbin, Kentucky 40702


                         INDEPENDENT AUDITOR'S REPORT
                         ----------------------------


July 29, 1998

To the Board of Directors and Stockholders
Cumberland Mountain Bancshares, Inc. and Subsidiaries
Middlesboro, Kentucky


We have audited the accompanying consolidated balance sheets of Cumberland
Mountain Bancshares, Inc. and Subsidiaries as of June 30, 1998, 1997 and 1996,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cumberland Mountain Bancshares,
Inc. and Subsidiaries as of June 30, 1998, 1997 and 1996, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.


/s/ Marr, Miller & Myers, PSC

Certified Public Accountants


                                       41
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                          CONSOLIDATED BALANCE SHEETS
                                   June 30,

          
                                    ASSETS
                                    ------  
<TABLE> 
<CAPTION> 

                                                                         1998             1997              1996
                                                                       --------         --------          ------
<S>                                                                 <C>              <C>               <C>         
Cash and cash equivalents                                              $   1,664,459   $      698,741    $     874,085
Investment securities, held to maturity (market value $6,976,
  $10,016 and $638,992 at June 30, 1998, 1997 and 1996,
  respectively)                                                                6,976           10,016          638,992
Investment securities, available for sale, at market value                 3,397,560        4,173,959        3,680,168
Other investments, at market value                                           303,340          103,318                -
Mortgage-backed securities, available for sale, at market value            5,577,842        6,352,745        7,779,128
Loans, net of allowance for loan losses of $798,069, $305,819 and
  $179,584 at June 30, 1998, 1997 and 1996, respectively                 118,060,639       99,623,425       59,930,689
Accrued interest receivable                                                  985,245          738,406          312,427
Federal Home Loan Bank (FHLB) stock                                        1,688,100          724,400          436,200
Other real estate owned                                                      100,460           12,778                -
Premises and equipment, net                                                3,214,695        2,024,061          895,042
Property held for investment                                                 619,616                -                -
Other assets                                                                 287,147          193,325          151,652
                                                                      --------------   --------------    -------------


        TOTAL ASSETS                                                   $ 135,906,079   $  114,655,174    $  74,698,383
                                                                       =============   ==============    =============
</TABLE> 


The accompanying notes are an integral part of these consolidated financial
statements.



                                       42
<PAGE>
 
<TABLE> 
<CAPTION> 
                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------
                                                                           1998           1997           1996     
                                                                         --------       --------        ------    
<S>                                                                  <C>             <C>            <C>           
LIABILITIES                                                                                                       
   Deposits                                                          $  97,719,318   $ 91,596,448   $ 68,975,577  
   Advances from FHLB                                                   26,000,000     13,000,000      1,000,000  
   Notes payable                                                         1,747,719        714,593             --  
   Accrued interest payable                                                283,461        240,723        107,266  
   Other liabilities                                                     1,394,746        589,323         19,642  
                                                                     -------------   ------------   ------------  
            Total liabilities                                          127,145,244    106,141,087     70,102,485  
                                                                     -------------   ------------   ------------  
                                                                                                                  
OFF-BALANCE SHEET RISK, COMMITMENTS AND                                                                           
  CONTINGENCIES                                                                                                   
                                                                                                                  
STOCKHOLDERS' EQUITY                                                                                              
  Common stock, .01 par value, 8,000,000 shares authorized,                                                       
     (678,800 shares issued and outstanding June 30, 1998                                                         
     and 1997 and 510,000 shares issued and outstanding                                                           
     June 30, 1996)                                                          6,788          6,788        510,000  
  Unearned ESOP shares                                                  (1,552,797)      (986,423)            --  
  Preferred stock, 2,000,000 shares authorized, none issued and                                                   
     outstanding                                                                --             --             --  
  Paid-in capital                                                        5,541,930      5,541,930      1,023,381  
  Retained earnings                                                      4,844,981      4,093,620      3,367,048  
  Net unrealized gain (loss) on available for sale securities,                                                    
     net of tax effect                                                     (80,067)      (141,828)      (304,531)  
                                                                     -------------   ------------   ------------  
            Total stockholders' equity                                   8,760,835      8,514,087      4,595,898  
                                                                     -------------   ------------   ------------  
                                                                                                                  
                    TOTAL LIABILITIES AND STOCKHOLDERS'                                                           
                          EQUITY                                     $ 135,906,079   $114,655,174   $ 74,698,383  
                                                                     =============   ============   ============   
</TABLE> 

                                       43
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                        CONSOLIDATED STATEMENTS OF INCOME
                              Years Ended June 30,

<TABLE> 
<CAPTION> 
                                                                             1998             1997           1996
                                                                           --------         --------       --------
<S>                                                                   <C>               <C>              <C> 
INTEREST INCOME
     Loans                                                            $   10,071,996    $   6,574,471    $  4,149,536
     Mortgage-backed securities                                              354,822          434,602         634,719
     Investment securities and other interest-earning assets                 215,131          239,537         388,885
     FHLB stock                                                              107,557           41,778          29,290
                                                                      --------------    -------------    ------------
          Total interest income                                           10,749,506        7,290,388       5,202,430

INTEREST EXPENSE                                                           6,288,017        4,312,826       3,317,249
                                                                      --------------    -------------    ------------

NET INTEREST INCOME                                                        4,461,489        2,977,562       1,885,181

PROVISION FOR LOAN LOSSES                                                  1,108,099          203,277          58,012
                                                                      --------------    -------------    ------------

NET INTEREST INCOME AFTER PROVISION FOR
   LOAN LOSSES                                                             3,353,390        2,774,285       1,827,169
                                                                      --------------    -------------    ------------

NONINTEREST INCOME
     Loan fees and service charges                                           869,972          657,185         271,986
     Net gain (loss) on sales of investment securities                       112,544           49,957          20,190
     Other                                                                   134,782           16,295          20,087
                                                                      --------------    -------------    ------------
           Total noninterest income                                        1,117,298          723,437         312,263
                                                                      --------------    -------------    ------------

NET INTEREST AND OTHER INCOME                                              4,470,688        3,497,722       2,139,432
                                                                      --------------    -------------    ------------

NONINTEREST EXPENSE
    Salaries and employee benefits                                         1,356,409        1,186,342         975,297
    Data processing fee                                                      303,863          126,161         100,231
    SAIF deposit insurance premium                                            68,299          478,840         143,552
    Occupancy and equipment                                                  390,248          178,437         144,131
    Franchise and other taxes                                                119,757           93,952          34,090
    Advertising                                                              171,003          115,339          68,853
    Other                                                                    939,412          719,778         413,760
                                                                      --------------    -------------    ------------
           Total noninterest expense                                       3,348,991        2,898,849       1,879,914
                                                                      --------------    -------------    ------------
</TABLE> 
The accompanying notes are an integral part of these consolidated financial
statements.




                                       44
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                  CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
                              Years Ended June 30,
<TABLE> 
<CAPTION> 
                                                                            1998              1997            1996
                                                                         ---------         ---------        --------          
<S>                                                                   <C>               <C>              <C> 
INCOME BEFORE PROVISION FOR INCOME TAXES                                   1,121,697          598,873         259,518

PROVISION FOR INCOME TAXES                                                   370,336          189,923         113,827
                                                                      --------------    -------------    ------------

NET INCOME                                                            $      751,361    $     408,950    $    145,691
                                                                      ==============    =============    ============


PER SHARE DATA:
   Basic earnings per share                                           $       1.3206    $       .6626    $      .2857
                                                                      ==============    =============    ============
   Diluted earnings per share                                         $       1.3206    $       .6626    $      .2857
                                                                      ==============    =============    ============
                                                  
   Weighted average common and common equivalent  
      shares outstanding                                                     568,963          617,207         510,000
                                                                      ==============    =============    ============
</TABLE> 







The accompanying notes are an integral part of these consolidated financial
statements.


                                       45
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                              Years Ended June 30,
<TABLE> 
<CAPTION> 
                                                   Common Stock            Unearned ESOP Shares           
                                            ------------------------       ---------------------          Paid-In
                                            Shares            Amount       Shares         Amount          Capital
                                            ------            ------       ------         ------          -------  
<S>                                         <C>               <C>          <C>          <C>              <C>  
Balance, July 1, 1995                         510,000         $  510,000   $        -   $          -     $  1,023,381

For the year ended June 30, 1996:
   Net unrealized gain (loss) on
      available for sale securities,
      net of deferred tax                           -                  -            -              -                -
   Net income                                       -                  -            -              -                -
                                            ---------         ----------   ----------   ------------     ------------

Balance June 30, 1996                         510,000            510,000            -              -        1,023,381

For the year ended June 30, 1997:
    Net unrealized gain (loss) on
      available for sale securities,
      net of tax effect                             -                  -            -              -                -
    Net income                                      -                  -            -              -                -
    Common stock exchanged in
      conversion                             (510,000)          (510,000)           -              -          510,000
    Assets acquired in conversion
      from Cumberland Mountain
      Bancshares, M.H.C.                            -                  -            -              -           30,660
    ESOP shares acquired                            -                  -       56,073       (714,593)               -
    Assets acquired due to merger
      of subsidiary                                 -                  -            -              -                -
    Issuance of common stock                  678,800              6,788       27,183       (271,830)       3,977,889
                                            ---------         ----------   ----------   ------------     ------------

Balance June 30, 1997                         678,800              6,788       83,256       (986,423)       5,541,930

For the year ended June 30, 1998:
   Net unrealized gain (loss) on
       available for sale securities,
      net of tax effect                             -                  -            -              -                -
   Net income                                       -                  -            -              -                -
   ESOP shares acquired                             -                  -       37,123       (566,374)               -
                                            ---------         ----------   ----------   ------------     ------------

Balance, June 30, 1998                        678,800         $    6,788      120,379   $ (1,552,797)    $  5,541,930
                                            =========         ==========   ==========   ============     ============
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.




                                       46
<PAGE>

<TABLE> 
<CAPTION> 
 
                                   Net
                               Unrealized
                             Gain (Loss) On
                                Available
         Retained               For Sale
         Earnings              Securities            Total
         --------              ----------            -----
<S>                     <C>                     <C> 
        $  3,221,357        $     (146,963)        $   4,607,775




                   -              (157,568)             (157,568)
             145,691                     -               145,691
        ------------        --------------         -------------

           3,367,048              (304,531)            4,595,898





                   -               162,703               162,703
             408,950                     -               408,950

                   -                     -                     -


                   -                     -                30,660
                   -                     -              (714,593)

             317,622                     -               317,622
                   -                     -             3,712,847
        ------------        --------------         -------------

           4,093,620              (141,828)            8,514,087





                   -                61,761                61,761
             751,361                     -               751,361
                   -                     -              (566,374)
        ------------        --------------         -------------

        $  4,844,981        $      (80,067)        $   8,760,835
        ============        ==============         =============
</TABLE> 

                                       47
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                             Years Ended June 30,
<TABLE> 
<CAPTION> 
                                                                           1998             1997              1996
                                                                       ------------     ------------      --------
<S>                                                                   <C>               <C>              <C> 
CASH FLOW FROM OPERATING ACTIVITIES
   Net income                                                         $      751,361    $     408,950    $    145,691
   Adjustments to reconcile net income to net
        cash provided by operating activities:
        Depreciation                                                         158,446           87,624          75,908
        Amortization and accretion                                            18,559           12,196          10,353
        FHLB stock dividend                                                 (107,400)         (41,600)        (29,100)
        Provision for loan losses                                          1,108,099          203,278          58,012
        Gain (loss) on sales of mortgage-backed securities                         -            1,219         (32,602)
        Gain (loss) on sales of investment securities                       (112,544)         (51,176)         12,412
        Gain on sale of other real estate, net                               (19,204)          (3,286)              -
        Deferred income tax                                                  (49,970)         (65,060)         14,846
        Changes in assets and liabilities:
             Accrued interest receivable                                    (246,839)        (425,979)        (65,777)
             Other assets                                                    (93,822)         (41,676)        (33,567)
             Accrued interest payable                                         42,738          133,457          10,226
             Other liabilities                                               864,938          550,927           8,309
                                                                      --------------    -------------    ------------
                Net cash provided by (used in) operating activities        2,314,362          768,874         174,711
                                                                      --------------    -------------    ------------

CASH FLOW FROM INVESTING ACTIVITIES
   Proceeds from redemption of capital stock-FHLB                            202,400                -               -
   Purchase of FHLB stock                                                 (1,058,700)        (246,600)              -
   Proceeds on maturities of investment securities                         1,003,040          578,776       1,052,536
   Purchase of other securities                                           (3,821,557)        (103,318)     (3,535,540)
   Principal collected on mortgage-backed securities                       1,319,332          773,889       1,418,093
   Proceeds on sales of mortgage-backed securities                                 -          855,237       6,025,238
   Proceeds on sales of other securities                                   3,732,462                -               -
   Proceeds on sales of investment securities                                      -          101,376       1,967,048
   Principal  collected on investment securities called                      817,779           34,071               -
   Purchase of investment securities                                        (998,750)        (497,500)              -
   Purchase of mortgage-backed securities                                   (509,591)               -               -
   Net increase in loans                                                 (19,545,313)     (39,896,014)    (15,124,498)
   Purchase of land                                                                -                -         (75,000)
   Construction in progress                                                 (806,507)               -        (157,064)
   Purchases of equipment and improvements                                  (542,573)      (1,216,643)        (48,180)
   Proceeds from sale of other real estate owned                             391,597          378,233               -
   Investment in other real estate owned, net                               (460,075)        (387,725)              -
   Purchase of property held for investment                                 (619,616)               -               -
                                                                      --------------    -------------    ------------
                Net cash provided by (used in) investing activities      (20,896,072)     (39,626,218)     (8,477,367)
                                                                      --------------    -------------    ------------
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.


                                       48
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
                              Years Ended June 30,
<TABLE> 
<CAPTION> 
                                                                           1998             1997              1996
                                                                       ------------     ------------      --------
<S>                                                                    <C>              <C>               <C> 
CASH FLOW FROM FINANCING ACTIVITIES
   Borrowings from FHLB                                                   41,000,000       40,000,000       3,600,000
   Repayments to FHLB                                                    (28,000,000)     (28,000,000)     (2,600,000)
   Proceeds from other borrowings                                          1,012,029                -               -
   Payments on other notes                                                   (21,097)               -               -
   Net increase in deposits                                                6,122,870       22,620,871       6,380,745
   Proceeds from sale of common stock                                              -        3,712,847               -
   Purchase of unearned ESOP shares                                         (566,374)        (714,593)              -
   Proceeds from borrowings for ESOP shares                                        -          714,593               -
   Assets acquired in conversion                                                   -          348,282               -
                                                                      --------------    -------------    ------------
          Net cash provided by (used in) financing activities             19,547,428       38,682,000       7,380,745
                                                                      --------------    -------------    ------------


NET INCREASE (DECREASE) IN CASH AND CASH
    EQUIVALENTS                                                              965,718         (175,344)       (921,911)

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                 698,741          874,085       1,795,996
                                                                      --------------    -------------    ------------

CASH AND CASH EQUIVALENTS, END OF YEAR                                $    1,664,459    $     698,741    $    874,085
                                                                      ==============    =============    ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
  INFORMATION
    Cash payments for:
        Interest                                                      $    6,245,279    $   4,179,369    $  3,307,023
                                                                      ==============    =============    ============

        Income taxes                                                  $      656,368    $      66,248    $    196,640
                                                                      ==============    =============    ============
</TABLE> 
The accompanying notes are an integral part of these consolidated financial
statements.


                                      49
                                        
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE I - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
         ------------------------------------------

     The accounting policies that affect the significant elements of the
financial statements are summarized below:

     BASIS OF PRESENTATION AND ORGANIZATION: The consolidated financial
     --------------------------------------
         statements of Cumberland Mountain Bancshares, Inc. and Subsidiaries
         (the Company) include the accounts of the Company, Middlesboro Federal
         Bank, F.S.B. (the "Bank") and the Company's wholly-owned subsidiary,
         Home Mortgage Loan Corporation. All significant intercompany accounts
         and transactions have been eliminated. On December 12, 1996, the Boards
         of Directors of the Bank and the Mutual Holding Company adopted a Plan
         of Conversion and Reorganization (the "Plan") and in December, 1996 the
         Bank organized the Company under Tennessee law as a first-tier wholly
         owned subsidiary. Pursuant to the Plan: (i) the Mutual Holding Company
         converted to an interim federal stock savings bank and simultaneously
         merged with and into the Bank; (ii) the Mutual Holding Company ceased
         to exist and the 330,000 shares or 64.71% of the outstanding Bank
         Common Stock held by the Mutual Holding Company was cancelled; and
         (iii) a second interim savings association ("Interim") was formed by
         the Company solely for the purpose of the merger with and into the
         Bank. As a result of the merger of Interim with and into the Bank, the
         Bank became a wholly owned subsidiary of the Company operating under
         the name "Middlesboro Federal Bank, Federal Savings Bank" and the
         outstanding Public Bank Shares, which amounted to 180,000 shares or
         35.29% of the outstanding Bank Common Stock at September 30, 1996, was
         converted into the Exchange Shares pursuant to a ratio (the "Exchange
         Ratio"), which resulted in the holders of such shares (the "Public
         Stockholders") owning in the aggregate approximately the same
         percentage of the Common Stock outstanding upon the completion of the
         Conversion and Reorganization (i.e., the Conversion Stock and the
         Exchange Shares) as the percentage of Bank Common Stock Owned by them
         in the aggregate immediately prior to consummation of the Conversion
         and Reorganization, before giving effect to: (i) the exercise of
         dissenters' rights of appraisal by the holders of any shares of Bank
         Common Stock; (ii) the payment of cash in lieu of issuing fractional
         Exchange Shares; and (iii) any shares of Conversion Stock purchased by
         the Bank's stockholders in the Offerings or the ESOP thereafter. All
         necessary governmental and shareholder approvals for the Conversion and
         Reorganization were received. The Company's primary source of income is
         from its banking subsidiary which operates in Middlesboro, Kentucky
         with two branches in Pineville and Cumberland, Kentucky. The Bank's
         primary source of revenue is derived from net interest income on loans
         and investments.

     USE OF ESTIMATES: The preparation of financial statements in conformity
     ----------------
         with generally accepted accounting principles requires management to
         make estimates and assumptions that affect the reported amounts of
         assets and liabilities and disclosure of contingent assets and
         liabilities at the date of the financial statements and the reported
         amounts of revenues and expenses during the reporting period.
         Actual results could differ from those estimates.

         Material estimates that are particularly susceptible to significant
         change relate to the determination of the allowance for losses on loans
         and the valuation of real estate acquired in connection with
         foreclosures or in satisfaction of loans. In connection with the
         determination of the allowances for losses on loans and foreclosed real
         estate, management obtains independent appraisals for significant
         properties.

                                       50
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, Inc. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
         ------------------------------------------------------

         While management uses available information to recognize losses on
         loans and foreclosed real estate, future additions to the allowances
         may be necessary based on changes in local economic conditions. In
         addition, regulatory agencies, as an integral part of their examination
         process, periodically review the Company's allowances for losses on
         loans and foreclosed real estate. Such agencies may require the Company
         to recognize additions to the allowances based on their judgements
         about information available to them at the time of their examination.
         Because of these factors, it is reasonably possible that the allowances
         for losses on loans and foreclosed real estate may change materially in
         the near term.

     CASH AND CASH EQUIVALENTS: For purposes of reporting cash flows, cash and
     -------------------------
         cash equivalents include cash and due from banks, interest bearing
         deposits having maturities of 90 days or less with other financial
         institutions, federal funds sold and money market mutual funds.

     INVESTMENT SECURITIES: Investment securities that are held for short-term
     ---------------------
         resale are classified as trading securities and carried at fair value.
         Debt securities that management has the ability and intent to hold to
         maturity are classified as held to maturity and carried at cost,
         adjusted for amortization of premiums and accretion of discounts using
         the interest method. Other marketable securities are classified as
         available for sale and are carried at fair value. Realized and
         unrealized gains and losses on trading securities are included in net
         income. Unrealized gains and losses on securities available for sale
         are recognized as direct increases or decreases in stockholders'
         equity. Cost of securities sold is recognized using the specific
         identification method.

     MORTGAGE-BACKED SECURITIES: Mortgage-backed securities represent
     --------------------------
         participating interests in pools of long-term first mortgage loans
         originated and serviced by issuers of the securities. Mortgage-backed
         securities are carried at unpaid principal balances, adjusted for
         unamortized premiums and unearned discounts. Premiums and discounts are
         amortized using the interest method over the remaining period to
         contractual maturity, adjusted for anticipated prepayments. Management
         intends and has the ability to hold such securities to maturity. Should
         any be sold, cost of securities sold is determined using the specific
         identification method.

     LOANS: Loans are stated at unpaid principal balances, less the allowance 
     -----
         for loan losses and net deferred loan fees and unearned discounts.

         Unearned discounts on installment loans are recognized as income over
         the term of the loans using the interest method.

         Loan origination and commitment fees, as well as certain direct
         origination costs, are deferred and amortized as a yield adjustment
         over the lives of the related loans using the interest method.
         Amortization of deferred loan fees is discontinued when a loan is
         placed on nonaccrual status.

                                       51
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE I - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
         ------------------------------------------------------

         Loans are placed on nonaccrual when a loan is specifically determined
         to be impaired or when principal or interest is delinquent for 90 days
         or more. Any unpaid interest previously accrued on those loans is
         reversed from income. Interest income generally is not recognized on
         specific impaired loans unless the likelihood of further loss is
         remote. Interest payments received on such loans are applied as a
         reduction of the loan principal balance. Interest income on other
         nonaccrual loans is recognized only to the extent of interest payments
         received.

     ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
     -------------------------
         level which, in management's judgement, is adequate to absorb credit
         losses inherent in the loan portfolio. The amount of the allowance is
         based on management's evaluation of the collectibility of the loan
         portfolio, including the nature of the portfolio, credit
         concentrations, trends in historical loss experience, specific impaired
         loans, and economic conditions. Allowances for impaired loans are
         generally determined based on collateral values or the present value of
         estimated cash flows. The allowance is increased by a provision for
         loan losses, which is charged to expense, and reduced by charge-offs,
         net of recoveries.

     ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
     --------------------------------------------------------------
     EXTINGUISHMENT OF LIABILITIES:  The FASB has issued SFAS No. 125, 
     -----------------------------
         "Accounting for Transfers and Servicing of Financial Assets and
         Extinguishment of Liabilities", which is effective for the Company's
         fiscal year beginning July 1, 1997. SFAS No. 125 provides standards for
         distinguishing transfers of financial assets that are sales from
         transfers that are secured borrowings. The impact of the adoption of
         SFAS No. 125 upon the results of operations of the Company was not
         material.

     ACCOUNTING FOR IMPAIRMENT OF LOANS: The Company's measurement of impaired
     ----------------------------------
         loans includes those loans which are performing according to all
         contractual terms of the loan agreement but may have substantive
         indication of potential credit weakness. As of June 30, 1998,
         $1,729,290 of loans were considered impaired by the Company and carried
         on a non-accrual basis. These loans were measured for impairment using
         the fair value of collateral or using the present value of the expected
         future cash flows discounted at the loan's effective rate. If as a
         result of these measurements, any loans required valuation allowances,
         they were included within the overall allowance for loan losses at June
         30, 1998. Residential mortgages and consumer loans and leases outside
         the scope of SFAS No. 114 are collectively evaluated for impairment.

     PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
     ----------------------
         accumulated depreciation and amortization. Depreciation and
         amortization are computed using the straight-line method over the
         estimated useful lives of the related assets, except for leasehold
         improvements for which the lesser of the estimated useful life of the
         asset or the term of the lease is used. The useful lives used in
         computing depreciation and amortization are as follows:

                                       52
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE I - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
         ------------------------------------------------------

                                                                        Years
                                                                        -----
     Office buildings and improvements                                    39
     Furniture, fixtures and equipment                                     7
     Leasehold improvements                                              5-15

     Gains and losses on routine dispositions are reflected in current
     operations. Maintenance, repairs and minor improvements are charged to
     operating expenses, and major replacements and improvements are
     capitalized.

     OTHER REAL ESTATE OWNED: Other real estate owned ("OREO") represents
     -----------------------
         property acquired through foreclosure proceedings held for sale and
         real estate held for investment. OREO is carried at its fair value, net
         of a valuation allowance established to reduce cost to fair value.
         Losses are charged to the valuation allowance and recoveries are
         credited to the allowance. Declines in market value and gains and
         losses on disposal are reflected in current operations in OREO expense.
         Recoverable costs relating to the development and improvement of OREO
         are capitalized whereas routine holding costs are charged to expense.
         The sales of these properties are dependent upon various market
         conditions. Management is of the opinion that such sales will result in
         net proceeds at least equal to present carrying values.

     ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS: The FASB issued SFAS No. 
     ----------------------------------------------
         121, "Accounting for the Impairment of Long-Lived Assets and for Long-
         Lived Assets to be Disposed Of," which was effective for the Company's
         fiscal year beginning July 1, 1996. SFAS No. 121 requires that long-
         lived assets and certain identifiable intangibles to be held and used
         be reviewed for impairment whenever events or changes in circumstances
         indicate the carrying amount of an asset may not be recoverable. If the
         sum of the expected future cash flows from the use of the asset and its
         eventual disposition is less than the carrying amount of the asset, an
         impairment loss is recognized. SFAS No. 121 also requires that certain
         assets to be disposed of be measured at the lower of carrying amount or
         the net realizable value. The impact of adopting SFAS No. 121 upon the
         results of operations of the Company was not material.

     INCOME TAXES: The Company follows the liability method which establishes
     ------------
         deferred tax assets and liabilities for the temporary differences
         between the financial reporting bases and the tax bases of the
         Company's assets and liabilities at enacted tax rates expected to be in
         effect when such amounts are realized or settled. Net deferred tax
         assets, whose realization is dependent on taxable earnings of future
         years, are recognized when a more-likely-than-not criterion is met,
         that is, unless a greater than fifty percent probability exists that
         the tax benefits will not actually be realized sometime in the future.

     Effective April 1, 1995, federal regulations restricted the amount of
         deferred tax assets that can be used to meet regulatory capital
         requirements to an amount that the institution expects to realize
         within one year, or ten percent of Tier 1 capital, whichever is less.

                                       53
<PAGE>
      
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
         ------------------------------------------------------

         The Company and its subsidiary file consolidated tax returns with the
         federal and state taxing authorities. A tax sharing agreement exists
         between the Company and the Bank whereby taxes for the Bank are
         computed as if the Bank were a separate entity. Amounts to be paid or
         credited with respect to current taxes are paid to or received from the
         Company.

     EARNINGS PER SHARE: Earnings per share of common stock is computed by
     ------------------
         dividing net income by the weighted average number of shares of common
         stock and common stock equivalents outstanding during the period.

     ACCRUED COMPENSATED ABSENCES:  The Company requires all earned vacation to 
     ----------------------------
         be taken by their employees.  There is no liability for compensated 
         absences reflected in the accompanying financial statements due to the 
         immateriality of the accrual.

     STOCK-BASED COMPENSATION PLANS: Effective in 1996, the Company adopted the
     ------------------------------
         disclosure option of SFAS No. 123, "Accounting for Stock-Based
         Compensation" (SFAS 123), which requires that companies not electing to
         account for stock-based compensation as prescribed by the statement,
         disclose the pro forma effects on earnings and earnings per share as if
         SFAS No. 123 had been adopted. Additionally, certain other disclosures
         are required with respect to stock compensation and the assumptions
         used to determine the pro forma effects of SFAS No. 123.

NOTE 2 - INVESTMENT SECURITIES
         ---------------------

     The carrying value, unrealized gains (losses) and estimated market value of
investment securities held to maturity and other investments are summarized as
follows:
<TABLE> 
<CAPTION> 

                                                                  Gross             Gross        Estimated
                                             Amortized         Unrealized        Unrealized        Market
                                                Cost              Gains            Losses          Value
                                            -----------       -----------       -----------      ----------
<S>                                         <C>               <C>               <C>              <C> 
June 30, 1998
-------------
    Municipal bond                          $     6,976       $         -       $        -       $    6,976
                                            ===========       ===========       ==========       ==========

    Powell Valley National Bank, Inc.       $   180,000       $         -       $        -       $  180,000
    Intrieve Corporation                         15,000                 -                -           15,000
    CBES Bancorp, Inc.                          109,957                 -            1,617          108,340
                                            -----------       -----------       ----------       ----------
                                            $   304,957       $         -       $    1,617       $  303,340
                                            ===========       ===========       ==========       ==========
</TABLE> 

                                       54
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
         --------------------------------
<TABLE> 
<CAPTION> 
                                                                  Gross             Gross        Estimated
                                             Amortized         Unrealized        Unrealized        Market
                                                Cost              Gains            Losses          Value
                                            -----------       -----------       -----------      ----------
<S>                                         <C>               <C>               <C>              <C> 
June 30, 1997
-------------
   Municipal bond                           $    10,016       $         -       $        -       $   10,016
                                            ===========       ===========       ==========       ==========

   NCF Financial Corporation                $    88,318       $         -       $        -       $   88,318
   Intrieve Corporation                          15,000                 -                -           15,000
                                            -----------       -----------       ----------       ----------
                                            $   103,318       $         -       $        -       $  103,318
                                            ===========       ===========       ==========       ==========

June 30, 1996
-------------
   Certificates of deposit                  $   576,000       $         -       $        -       $  576,000
   U.S. League stock and other                   62,992                 -                -           62,992
                                            -----------       -----------       ----------       ----------
                                            $   638,992       $         -       $        -       $  638,992
                                            ===========       ===========       ==========       ==========
</TABLE> 

         The Company has the intent and ability to hold these securities to
maturity.

         The carrying value, unrealized gains (losses) and estimated market
value of investment securities available for sale are summarized as follows:

<TABLE> 
<CAPTION> 
                                                                  Gross             Gross         Estimated
                                             Amortized         Unrealized        Unrealized         Market
                                                Cost              Gains            Losses           Value
                                            -----------       -----------       -----------      ------------
<S>                                         <C>               <C>               <C>              <C> 
June 30, 1998
-------------
   U.S. Treasury and government agencies    $ 2,492,872       $         -       $  (15,371)      $  2,477,501
   Franklin U.S. Government Securities
      Fund                                    1,000,000                 -          (79,941)           920,059
                                            -----------       -----------       ----------       ------------
                                            $ 3,492,872       $         -       $  (95,312)      $  3,397,560
                                            ===========       ===========       ==========       ============

June 30, 1997
-------------
   U.S. Treasury and government agencies    $ 3,315,369       $         -       $  (50,802)      $  3,264,567
   Franklin U.S. Government Securities
      Fund                                    1,000,000                 -          (90,608)           909,392
                                            -----------       -----------       ----------       ------------
                                            $ 4,315,369       $         -       $ (141,410)      $  4,173,959
                                            ===========       ===========       ==========       ============

June 30, 1996
-------------
   U.S. Treasury and government agencies    $ 2,852,651       $    16,168       $  (74,041)      $  2,794,778
   Franklin U.S. Government Securities
      Fund                                    1,000,000                 -         (114,610)           885,390
                                            -----------       -----------       ----------       ------------
                                            $ 3,852,651       $    16,168       $ (188,651)      $  3,680,168
                                            ===========       ===========       ==========       ============
</TABLE> 

                                       55
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998



NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
         ---------------------------------

     The gross realized gains, losses and proceeds on sales of other securities
and investment securities are as follows:
<TABLE> 
<CAPTION> 
                                                                           1998             1997             1996
                                                                         --------         --------         --------
         <S>                                                          <C>               <C>              <C> 
         Proceeds                                                     $    3,732 462    $     101,376    $  1,967,048
                                                                      ==============    =============    ============

         Gross realized gains                                         $      112,544    $      51,176    $        798
                                                                      ==============    =============    ============

         Gross realized losses                                        $            -    $           -    $     13,210
                                                                      ==============    =============    ============
</TABLE> 

     The amortized cost and estimated market value of investment securities, by
contractual maturity, are as follows:
<TABLE> 
<CAPTION> 

                                            June 30, 1998                June 30, 1997                 June 30, 1996
                                    ---------------------------    --------------------------     ---------------------------
                                                     Estimated                      Estimated                      Estimated       
                                     Amortized         Market       Amortized         Market       Amortized         Market     
                                        Cost           Value           Cost           Value           Cost           Value      
                                    -----------     -----------    -----------     ----------     -----------     -----------   
<S>                                 <C>             <C>            <C>             <C>            <C>             <C>           
Due in one year or less             $ 1,003,330     $ 1,001,309    $ 1,003,041     $  994,102     $   578,777     $   578,777   
Due after one year through                                                                                                      
  five years                            504,042         502,152      1,504,589      1,473,833       2,010,015       1,935,974   
Due after five years through                                                                                                    
  ten years                             498,254         495,395              -              -               -               -   
Due after ten years                     494,212         485,621        817,755        806,648         852,651         868,819   
                                    -----------     -----------    -----------     ----------     -----------     -----------   
                                                                                                                                
                                      2,499,848       2,484,477      3,325,385      3,274,583       3,441,443       3,383,570   
Franklin U.S. Government                                                                                                        
  Securities Fund                     1,000,000         920,059      1,000,000        909,392       1,000,000         885,390   
Other investments                       304,957         303,340        103,318        103,318          50,200          50,200   
                                    -----------     -----------    -----------     ----------     -----------     -----------   
                                                                                                                                
      Total investment securities   $ 3,804,805     $ 3,707,876    $ 4,428,703     $4,287,293     $ 4,491,643     $ 4,319,160   
                                    ===========     ===========    ===========     ==========     ===========     ===========    
</TABLE>

There were no issues held at June 30, 1998, 1997 and 1996, that exceeded 10% of
stockholders' equity.

                                       56
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE 3 - MORTGAGE-BACKED SECURITIES
         --------------------------

     Mortgage-backed securities are summarized as follows:
<TABLE> 
<CAPTION> 
                                                                  Gross            Gross          Estimated
                                             Amortized         Unrealized        Unrealized         Market
                                                Cost              Gains            Losses           Value
                                            -----------       -----------       -----------      -----------
<S>                                         <C>               <C>               <C>              <C> 
June 30, 1998
-------------
     GNMA                                   $   515,486        $       -        $   (1,892)       $   513,594  
     FNMA                                     4,605,380           10,985           (31,200)         4,585,165  
     FHLMC                                      479,499                -              (416)           479,083  
                                            -----------        ---------        ----------        -----------  
          Total                             $ 5,600,365        $  10,985        $  (33,508)       $ 5,577,842  
                                            ===========        =========        ==========        ===========  
                                                                                                               
June 30, 1997                                                                                                  
-------------                                                                                                  
     GNMA                                   $   612,578        $   1,478        $   (1,177)       $   612,879  
     FNMA                                     5,813,648            2,380           (76,162)         5,739,866  
                                            -----------        ---------        ----------        -----------  
          Total                             $ 6,426,226        $   3,858        $  (77,339)       $ 6,352,745  
                                            ===========        =========        ==========        ===========  
                                                                                                               
June 30, 1996                                                                                                  
-------------                                                                                                  
     GNMA                                   $ 1,591,209        $       -        $  (19,173)       $ 1,572,036  
     FNMA                                     6,476,847                -          (269,755)         6,207,092  
                                            -----------        ---------        ----------        -----------  
          Total                             $ 8,068,056        $       -        $ (288,928)       $ 7,779,128  
                                            ===========        =========        ==========        ===========   
</TABLE> 

     Mortgage-backed certificates represent participating interests in pools of
long-term first mortgage loans. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties.

     The proceeds, gross realized gains and losses on sales of mortgage-backed
securities are as follows:
<TABLE> 
<CAPTION> 
                                                              1998              1997               1996
                                                              ----              ----               ----
<S>                                                         <C>              <C>               <C> 
Proceeds                                                    $       -        $  855,237        $  6,025,238
                                                            =========        ==========        ============

Gross realized gains                                        $       -        $    2,014        $     37,970
                                                            =========        ==========        ============

Gross realized losses                                       $       -        $    3,233        $      5,368
                                                            =========        ==========        ============
</TABLE> 

     At June 30, 1998, mortgage-backed securities with an amortized cost of
$4,540,573 and estimated market value of $4,582,015 were pledged to secure
deposits.

                                       57
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998


NOTE 4 - LOANS
         -----

     Major classifications of loans are summarized as follows (dollars in 
thousands):

<TABLE> 
<CAPTION> 
                                                               1998            1997             1996    
                                                               ----            ----             ----    
     <S>                                                    <C>             <C>             <C>         
     Mortgage loans:                                                                                    
        One-to-four family                                  $  68,328       $  54,590       $    38,937 
        Multi-family                                            2,421           1,441             1,877 
        Commercial                                             19,442          17,402             9,307 
     Construction:                                                                                      
        One-to-four family                                      1,393           8,998             2,964 
        Multi-family and commercial                               884               -               146 
     Commercial                                                10,682           8,311             3,432 
     Consumer                                                  16,647          13,061             5,993 
                                                            ---------       ---------       ----------- 
           Total loans                                        119,797         103,803            62,656 
                                                                                                        
     Less:                                                                                              
        Unearned discounts                                        (25)           (126)             (596) 
        Allowance for loan losses                                (798)           (306)             (180) 
        Loans in process                                         (913)         (3,748)           (1,949) 
                                                            ---------       ---------       ----------- 
                                                                                                        
           Net loans                                        $ 118,061       $  99,623       $    59,931 
                                                            =========       =========       ===========  
</TABLE> 

     Activity in the allowance for loan losses is summarized as follows:

<TABLE> 
<CAPTION>
                                                               1998             1997              1996
                                                               ----             ----              ----
     <S>                                                    <C>              <C>              <C>    
     Balance, beginning of year                             $ 305,819        $ 179,584        $  148,182
     Provision for loan losses                              1,108,099          203,277            58,012
     Charge-offs                                             (726,657)         (99,680)          (36,209)
     Recoveries                                               110,808           22,638             9,599
                                                            ---------        ---------        ----------
     Balance, end of year                                   $ 798,069        $ 305,819        $  179,584
                                                            =========        =========        ==========
</TABLE> 

                                       58
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 4 - LOANS (CONTINUED)
         ----------------- 

     Non-accrual loans and their impact on interest income are as follows:

<TABLE> 
<CAPTION> 
                                                                      1998           1997           1996     
                                                                      ----           ----           ----     
                                                                                                             
<S>                                                                <C>             <C>            <C>        
         Non-accrual loans                                         $1,729,290      $ 627,820      $349,000   
                                                                   ==========      =========      ========   
                                                                                                             
     Impact on interest income:                                                                              
        Interest income that would have been recorded on                                                     
           non-accrual loans in accordance with original terms     $   31,306      $  14,402      $  5,802   
                                                                   ==========      =========      ========   
                                                                                                             
     Interest income actually received and recorded during                                                   
        the period                                                 $   86,465      $  34,254      $ 17,407   
                                                                   ==========      =========      ========    
</TABLE> 

     The maturities of all loans at June 30, 1998 which have predetermined or 
floating or adjustable rates follows (amounts in thousands):

<TABLE> 
<S>                                                              <C>  
     Predetermined Rate:
           1 month - 1 year                                      $  14,634
           1 year - 5 years                                         16,129
           Over 5 years                                             16,195
                                                                 ---------
                 Total                                           $  46,958
                                                                 =========
                                                                  
     Floating or Adjustable Rates:                                
           1 month - 1 year                                      $     200
           1 year - 5 years                                          1,945
           Over 5 years                                             70,694
                                                                 ---------
                 Total                                           $  72,839
                                                                 =========
</TABLE> 

     The adjustable rate loans have interest rate adjustment limitations tied to
various indexes. Future market factors may affect the correlation of the
interest rate adjustment with the rates the Company pays on short-term deposits
which have primarily been utilized to fund these loans.

     The Company is engaged principally in providing first mortgage loans and
accepting deposits. Substantially all of the Company's mortgage loan portfolio
at June 30, 1998, 1997 and 1996, represents loans to borrowers in Southeastern
Kentucky and Northeastern Tennessee. The Company's policy is to make mortgage
loans that generally do not exceed 80% of the appraised value of the underlying
property. The Company's loans on nonresidential properties are collateralized by
churches, hospitals and other business properties.

     The Company has a blanket pledge to the Federal Home Loan Bank of
$39,000,000 of their first mortgages on one-to-four family residences to secure
their borrowings.



                                       59
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE 4 - LOANS (CONTINUED)
         -----------------

     Loans made to officers and directors of the Company and their interests are
presented below.

<TABLE> 
<CAPTION> 
                                        Balance,                                                 Balance,
                                    Beginning of Year         New Loans         Repayments      End of Year
                                    -----------------         ---------         ----------      -----------
<S>                                 <C>                       <C>               <C>             <C>     
     1998                              $1,064,521             $856,374          $645,672        $1,275,223
                                       ==========             ========          ========        ==========
</TABLE> 

NOTE 5 - OTHER REAL ESTATE OWNED
         -----------------------

     Federal banking regulations require the Company to dispose of all OREO
acquired through foreclosure within five years of acquisition, with a
possibility for additional extensions, each of up to five years. Failure to
receive additional extensions could result in losses on OREO.

     Loans converted to OREO through foreclosure proceedings totaled $460,075
and $387,725 for the years ended June 30, 1998 and 1997, respectively. Sales of
OREO that were financed by the Company totaled $391,597 and $378,233 for the
years ended June 30, 1998 and 1997, respectively. At June 30, 1996, there was no
real estate acquired in settlement of loans.

NOTE 6 - ACCRUED INTEREST RECEIVABLE
         ---------------------------   


    Accrued interest receivable is comprised of the following:

<TABLE> 
<CAPTION> 
                                                               1998            1997            1996     
                                                               ----            ----            ----     
                                                                                                        
     <S>                                                    <C>             <C>            <C>           
     Investment securities                                  $   23,859      $  24,005      $    27,203  
     Mortgage-backed securities                                 34,467         33,609           41,362  
     Loans                                                     926,919        680,792          243,862  
                                                            ----------      ---------      -----------  
              Total                                         $  985,245      $ 738,406      $   312,427  
                                                            ==========      =========      ===========   
</TABLE> 

NOTE 7 - PREMISES AND EQUIPMENT
         ---------------------- 

     Premises and equipment is comprised of the following:

<TABLE>   
<CAPTION> 
                                                              1998            1997             1996     
                                                              ----            ----             ----     
     <S>                                                  <C>             <C>              <C>           
     Land                                                 $   155,000     $   155,000      $   155,000  
     Office buildings and improvements                      1,695,155       1,532,094          470,485  
     Furniture, fixtures and equipment                      1,403,077       1,023,565          711,467  
     Construction in progress                                 806,507               -          157,064  
                                                          -----------     -----------      -----------  
           Total premises and equipment                     4,059,739       2,710,659        1,494,016  
     Less accumulated depreciation                            845,044         686,598          598,974  
                                                          -----------     -----------      -----------  
                                                                                                        
     Net premises and equipment                           $ 3,214,695     $ 2,024,061      $   895,042  
                                                          ===========     ===========      ===========   
</TABLE> 
                                       60
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998



NOTE 8 - PROPERTY HELD FOR INVESTMENT
         ----------------------------

     Home Mortgage Loan Corporation, an operating subsidiary of the Company, has
acquired four pieces of property to be used for future development and/or
resale. The value of these properties at June 30, 1998 was $619,616.

NOTE 9 - DEPOSITS
         -------- 

<TABLE> 
<CAPTION> 

     Deposits are summarized as follows:

                                                                  Weighted
                                                                  Average Rate      Amount           Percent
                                                                  ------------      ------           -------
<S>                                                               <C>             <C>                <C>  
     June 30, 1998 
     -------------
       Balance by interest rate: 
       Transaction accounts:
          Demand and NOW checking (including
           non-interest bearing deposits of $2,425,957)                2.58%      $  10,114,022        10.35%
       Savings                                                         1.93%          9,156,751         9.37
       Money market                                                    3.59%            469,336          .48
                                                                                  -------------      -------
          Total transaction accounts                                                 19,740,109        20.20
                                                                                  -------------      -------

       Certificates of deposit accounts:
         2.75% - 3.00%                                                                   79,045          .08
         3.01% - 5.00%                                                                   98,986          .10
         5.01% - 7.00%                                                               77,801,178        79.62
                                                                                  -------------      -------
                     Total certificates of deposit accounts                          77,979,209        79.80
                                                                                  -------------      -------
                     Total                                                        $  97,719,318       100.00%
                                                                                  =============      =======

      Weighted average annual interest rate on total deposits                                           5.03%
                                                                                                     =======

     June 30, 1997 
     -------------
       Balance by interest rate: 
       Transaction accounts:
          Demand and NOW checking (including
           non-interest bearing deposits of $1,480,424)                2.52%      $   9,780,631        10.68%
          Savings                                                      2.77%          9,642,903        10.53
          Money market                                                 3.93%            984,299         1.07
                                                                                  -------------      -------
                     Total transaction accounts                                      20,407,833        22.28
                                                                                  -------------      -------
</TABLE> 



                                       61
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 9 - DEPOSITS (CONTINUED)
         -------------------- 
<TABLE> 
<CAPTION> 

                                                                  Weighted
                                                                  Average Rate      Amount           Percent
                                                                  ------------      ------           -------
<S>                                                               <C>               <C>              <C>       
     Certificates of deposit accounts:
           2.75% - 3.00%                                                                   76,904        .08
           3.01% - 5.00%                                                                6,966,299       7.61
           5.01% - 7.00%                                                               64,145,412      70.03
                                                                                    -------------    -------
                   Total certificates of deposit accounts                              71,188,615      77.72
                                                                                    -------------    -------
                   Total                                                            $  91,596,448     100.00%
                                                                                    =============    =======

     Weighted average annual interest rate on total deposits                                            5.02%
                                                                                                     =======

     June 30, 1996 
     -------------
      Balance by interest rate: 
      Transaction accounts:
              Demand and NOW checking (including
                 non-interest bearing deposits of $1,377,450)          2.29%        $   8,712,164      12.63%
              Savings                                                  2.74%            9,145,766      13.26
              Money market                                             3.00%              510,604        .74
                                                                                    -------------    -------
                   Total transaction accounts                                          18,368,534      26.63
                                                                                    -------------    -------

     Certificates of deposit accounts:
           3.01% - 5.00%                                                                7,857,103      11.39
           5.01% - 7.00%                                                               42,749,940      61.98
                                                                                    -------------    -------
                   Total certificates of deposit accounts                              50,607,043      73.37
                                                                                    -------------    -------
                   Total                                                            $  68,975,577     100.00%
                                                                                    =============    =======

     Weighted average annual interest rate on total deposits                                            4.97%
                                                                                                     =======
</TABLE> 

<TABLE> 
<CAPTION> 

     Remaining contractual maturity of certificates of deposit accounts:

                                                 1998                      1997                      1996
                                                 ----                      ----                      ----
     <S>                            <C>            <C>        <C>            <C>        <C>             <C>         
     Under one year                 $  55,720,269    71.46%   $  55,714,946    78.26%   $  35,574,688    70.30%
     One to three years                20,195,255    25.90       14,490,813    20.36       12,569,711    24.84
     Three to five years                2,038,140     2.61          849,046     1.19        1,809,312     3.58
     Five to ten years                      9,058      .01          100,116      .14          556,834     1.10
     Ten to twenty years                   16,487      .02           33,694      .05           96,498      .18
                                    -------------  -------    -------------  -------    -------------   ------
             Total                  $  77,979,209   100.00%   $  71,188,615   100.00%   $  50,607,043   100.00%
                                    =============  =======    =============  =======    =============   ======
</TABLE> 


                                       62
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE 9 - DEPOSITS (CONTINUED)
         --------------------

     The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $16,127,000, $17,552,219 and
$5,153,492 at June 30, 1998, 1997 and 1996, respectively.

<TABLE> 
<CAPTION> 

     Interest expense on deposits consists of the following:


                                                                 1998              1997             1996
                                                                 ----              ----             ----
<S>                                                       <C>              <C>               <C>         
         NOW checking and money market                      $   227,251      $    217,386      $    194,381
         Savings                                                244,153           249,743           269,887
         Certificates of deposit                              4,205,801         3,380,128         2,835,609
                                                            -----------      ------------      ------------
                  Total                                     $ 4,677,205      $  3,847,257      $  3,299,877
                                                            ===========      ============      ============

<CAPTION> 

NOTE 10 - FEDERAL INCOME TAXES
          --------------------

     Income taxes are comprised of the following:

                                                                 1998              1997             1996
                                                                 ----              ----             ----
<S>                                                       <C>              <C>               <C>         
     Current provision                                      $   463,330      $    254,710      $     98,981
     Deferred benefit                                           (92,944)          (64,787)           14,846
                                                            -----------      ------------      ------------
                                                            $   370,336      $    189,923      $    113,827
                                                            ===========      ============      ============
</TABLE> 

     Deferred tax assets and liabilities were comprised of the following:

<TABLE> 
<CAPTION> 

                                                                                                   1998
                                                                                                   ---- 
<S>                                                                                          <C>    
         Tax bases over financial bases for loans (loan loss reserve and discounts)            $    111,952
         Deferred compensation                                                                       66,248
         Retirement plans                                                                            86,663
         Depreciation                                                                               (96,312)
         Unrealized gains (losses) on securities                                                     40,414
                                                                                               ------------
                Net deferred tax asset                                                         $    208,965
                                                                                               ============
</TABLE> 


                                       63
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
          --------------------------------

     The Company's effective tax rate varies from the statutory rate of
thirty-four percent. The reasons for this difference are as follows:

<TABLE> 
<CAPTION> 

                                                                                                     1998
                                                                                                     ---- 
<S>                                                                                          <C>    
     Computed "expected" tax provision                                                         $    463,330
     Increase (reduction) of taxes:
            Tax-exempt income                                                                        36,819
            Allowance for loan losses                                                               (76,495)
            Retirement plans                                                                        (30,257)
            Deferred compensation                                                                   (16,282)
            Depreciation                                                                             21,065
            Other                                                                                   (27,844)
                                                                                               ------------
                Total                                                                          $    370,336
                                                                                               ============
</TABLE> 

NOTE I I - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES
           -----------------------------------------------------

     CONCENTRATION OF CREDIT RISK: The Company's core customer loan origination
     ------------------------
         base is located in southeastern Kentucky and Northeastern Tennessee. At
         June 30, 1998, approximately seventy-seven percent of the Company's
         loan portfolio was secured by real estate. Mortgage loans secured by
         one to four family properties comprised approximately fifty-eight
         percent of total mortgage loans at June 30, 1998.

     OFF-BALANCE-SHEET ITEMS: The Company enters into financial instruments with
     ------------------------
         off-balance-sheet risk in the normal course of business to meet the
         financing needs of its customers. These financial instruments include
         commitments to extend credit and commercial and standby letters of
         credit. These instruments involve, to varying degrees, elements of
         credit and interest-rate risk that are not recognized in the
         accompanying consolidated balance sheets.

         The Company's exposure to credit loss in the event of nonperformance by
         the other party to the financial instruments discussed above is
         represented by the contractual amount of those instruments. The Company
         uses the same credit policies in making commitments and conditional
         obligations as it does for on-balance- sheet instruments.

         A summary of financial instruments with off-balance-sheet risk at June
         30, 1998, is as follows (in thousands):

<TABLE> 
<CAPTION> 

                                                                                                    1998
                                                                                                    ----
<S>                                                                                          <C>    
         Commitments to extend credit                                                          $      1,589
         Unfunded lines of credit                                                                     2,444
         Commercial and standby letters of credit                                                       210
                                                                                               ------------
                Total                                                                          $      4,243
                                                                                               ============
</TABLE> 


                                       64
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE II - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
          -----------------------------------------------------------------

         Commitments to extend credit are agreements to lend to a customer as
         long as there is no violation of any condition established in the
         agreement. Commitments generally have fixed expiration dates or other
         termination clauses and may require payment of a fee. Since many of the
         commitments are expected to expire without being drawn upon, the total
         commitment amounts do not necessarily represent future cash
         requirements. The Company evaluates each customer's creditworthiness on
         a case-by-case basis. The amount of collateral obtained, if deemed
         necessary upon extension of credit, is based on management's credit
         evaluation of the counterparty. Collateral held varies but may include
         premises and equipment, inventory and accounts receivable. Unfunded
         lines of credit represent the undisbursed portion of lines of credit
         which have been extended to customers.

         Commercial and standby letters of credit are conditional commitments
         issued by the Company to guarantee the performance of a customer to a
         third party which typically do not extend beyond one year. The credit
         risk involved in issuing letters of credit is essentially the same as
         that involved in extending loans to customers. The Company typically
         holds certificates of deposit as collateral supporting those
         commitments, depending on the strength of the borrower.

     DIVIDENDS: Regulations limit the amount of dividends the Bank can pay in
     ----------
         any given year to that year's net income plus retained net income from
         the two preceding years. Additionally, the Bank and the Company cannot
         pay dividends which would cause either to be undercapitalized as
         defined by federal regulations.

     COMMITMENTS: The Company has entered into three noncancelable operating
     ------------
         leases for branch banking locations. At June 30, 1998, minimum rental
         commitments based on the remaining noncancelable lease terms were as
         follows:


             1999                                            $    89,820
             2000                                                 89,820
             2001                                                 89,820
             2002                                                 73,020
             2003                                                 60,000
             Thereafter                                          615,000
                                                             -----------
                                                             $ 1,017,480
                                                             ===========

         Total rent expense for the years ended June 30, 1998, 1997 and 1996 was
         $76,220, $20,020 and $13,020, respectively.

     INDEMNIFICATION AGREEMENTS: The Bank and the Company have entered into
     ---------------------------
         Indemnification Agreements (the "Indemnification Agreements") with all
         of the Bank's and the Company's directors. The Indemnification
         Agreements provide for retroactive as well as prospective
         indemnification to the fullest extent permitted by law against any and
         all expenses (including attorneys' fees and all other costs and
         obligations),



                                       65
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998


NOTE II - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
          -----------------------------------------------------------------

         judgements, fines, penalties and amounts paid in settlement in
         connection with any claim or proceeding arising out of the indemnitee's
         service as a director. The Indemnification Agreements also provide for
         the prompt advancement of expenses to the director in connection with
         investigating, defending or being a witness or participating in any
         proceeding. The Indemnification Agreements further provide a mechanism
         through which the director may seek court relief in the event the
         Company's or the Bank's Board of Directors (or other person appointed
         by such Board) determines that the director would not be permitted to
         be indemnified under applicable law. The Indemnification Agreements
         impose on the Bank and the Company the burden of proving that the
         director is not entitled to indemnification in any particular case. If
         a change in control (as defined) occurs, the director would be entitled
         to continue on as a director emeritus or as an advisory director for
         one year after the change in control, with annual renewal by the Board
         of Directors of the successor entity upon a duly adopted resolution.

         While not requiring the maintenance of directors' liability insurance,
         the Indemnification Agreements provide that the Bank or the Company may
         obtain such insurance, if desired. Further, the Indemnification
         Agreements provide that if the Bank or the Company pays a director
         pursuant to an Indemnification Agreement, the Bank or the Company will
         be subrogated to such director's rights to recover from third parties.

NOTE 12 - NOTES PAYABLE
          -------------

     Notes payable at June 30, are as follows:

<TABLE> 
<CAPTION> 
                                                                                    1998        1997            1996
                                                                                    ----        ----            ----
<S>                                                                           <C>           <C>          <C>       
         Powell Valley National Bank note; dated June, 1997; secured by ESOP
           shares; due in annual payments of $54,362 including
           interest at 9.5%, due June, 2021                                     $   502,210   $ 543,620    $       -
         Powell Valley National Bank note; dated June, 1997; secured by
           ESOP shares; due in annual payments of $17,908 including
           interest at 9.5%; due June, 2028                                         157,807     170,973            -
         Powell Valley National Bank note; dated June, 1998; secured by
           real estate; due in quarterly payments of $29,868 beginning
           September, 1999; including interest at 8.5% due June, 2014             1,000,000           -            -
         Individual note; dated January, 1998; secured by real estate;
           due in annual payments of $9,800 including interest at 5%;
           due January, 2008                                                         75,673           -            -
         Individual note, dated January, 1998; secured by real estate;
           due in monthly payments of $1,035 with no interest;
           due May, 1999                                                             12,029           -            -
                                                                                -----------   ---------    ---------
                                                                                $ 1,747,719   $ 714,593    $       -
                                                                                ===========   =========    =========
</TABLE> 



                                       66
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 12 - NOTES PAYABLE (CONTINUED)

  Maturities on the notes payable are as follows:

           1999                                     $       27,613
           2000                                             52,381
           2001                                             56,814
           2002                                             61,633
           2003                                             66,869
           After                                         1,482,409
                                                    --------------
                                                    $    1,747,719
                                                    ==============    

NOTE 13 - EMPLOYEE BENEFIT PLANS
          ----------------------
   On July 1, 1995, a 401(k) plan was adopted covering substantially all
employees. Each employee of the Company automatically becomes eligible to
participate in the plan on the July I immediately following the date on which
such employee attains the age of 18 and completes one year of service.

   Employees' before-tax contributions are limited based on restrictions
established by the Internal Revenue Service. In each plan year, the Company will
make matching contributions to each account equal to 25% of the employees
elective contributions. Employees are 100% vested at all times in their
contributions and regular matching contributions. In addition, the 401(k)
arrangement plan permits the Company to contribute a discretionary amount to all
of the participants for any plan year, and that contributions will be allocated
among the participants based upon their respective shares of the total
compensation paid during the plan year to all participants eligible. The
Company's contributions for the years ended June 30, 1998 and 1997 were $13,987
and $13,694, respectively. The Bank was a participant in the Financial
Institutions Retirement Fund in 1996, a multi-employer defined benefit pension
plan covering substantially all full-time employees who had completed one year
of continuous service. Retirement expense was $44,657 for the year ended June
30, 1996.

NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
          -----------------------------------

   Generally, the Company's practice and intent is to hold its financial
instruments to maturity, unless otherwise designated. Where available, quoted
market prices are used to determine fair value. However, many of the Company's
financial instruments lack quoted market prices. Although the Company has
incorporated what it considers to be appropriate estimation methodologies for
those financial instruments which lack quoted market prices, a significant
number of assumptions must be used in determining such estimated fair values.
Such assumptions include subjective assessments of current market conditions,
perceived risks associated with these financial instruments and other factors.
Different assumptions might be considered by the user of the financial
statements to be more appropriate, and the use of alternative assumptions or
estimation methodologies could have a significant effect on the resulting
estimated fair values. The estimated fair value presented neither include nor
give effect to the values associated with the Company's business, existing
customer relationships, and branch banking network, among other things.



                                      67
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998



NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
          -----------------------------------------------

   The following estimates of the fair value of certain financial instruments
held by the Company include only instruments that could reasonably be evaluated.
The investment securities portfolio was evaluated using market quotes as of June
30, 1998. The fair value of the loan portfolio was evaluated using market quotes
for similar financial instruments, where available. Otherwise, discounted cash
flows, after adjusting for credit deterioration, were used based upon current
rates the Company would use in extending credit with similar characteristics.
These rates may not necessarily be the same as those which might be used by
other financial institutions for similar loans. Cash and cash equivalent are
valued at cost. The fair values disclosed for checking accounts, savings
accounts, and certain money market accounts are, by definition, equal to the
amount payable on demand at the reporting date, i.e., their carrying amounts.
Fair value for time deposits are estimated using a discounted cash flow
calculation that applies current interest rates to aggregated expected
maturities. Standby letters of credit and commitments to extend credit were
valued at book value as the majority of these instruments are based on variable
rates.

   These evaluations may incorporate specific value to the Company in
accordance with its asset/liability strategies, interest rate projections and
business plans at a specific point in time, and therefore, should not
necessarily be viewed as liquidation value. They should also not be used in
determining overall value of the Company due to undisclosed and intangible
aspects such as business and franchise value, and due to changes to assumptions
of interest rates and expected cash flows which might need to be made to reflect
expectations of returns to be earned on instruments with higher credit risks.

   The table below illustrates the estimated fair value of the Company's
financial instruments as of June 30 using the assumptions described above (in
thousands):

<TABLE> 
<CAPTION> 
       <S>                                                              <C>    
       Cash and cash equivalents                                        $     1,664
                                                                          =========
       Investment securities                                            $     9,286
                                                                          =========
       Loans                                                            $   112,825
                                                                          =========
       Deposits                                                         $    91,736
                                                                          =========
       Advances from FHLB                                               $    18,000
                                                                          =========
       Notes payable                                                    $     9,748
                                                                          =========
       Standby letters of credit                                        $       210
                                                                          =========
       Commitments to extend credit and unfunded lines of credit        $     4,033
                                                                          =========

</TABLE> 
NOTE 15 - DIRECTORS' RETIREMENT PLAN
          --------------------------

   The Company has adopted the Middlesboro Federal Bank, Federal Savings Bank
Retirement Plan for Directors (the "Directors' Plan") pursuant to which
directors of the Company are entitled to receive, upon retirement, sixty monthly
payments in the amount of 75% of the average monthly fees that the respective
director received for service on the Board during the twelve-month period
preceding termination of service on the Board, subject to a twenty year vesting
schedule. In connection with the adoption of the Directors' Plan, the Bank
incurred an expense of $70,940



                                      68
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998


NOTE 15 - DIRECTORS' RETIREMENT PLAN (CONTINUED)
          --------------------------------------

and $147,560 for the years ended June 30, 1998 and 1997, respectively. The
liability accrued under this plan was $193,900 and $137,360 at June 30, 1998 and
1997, respectively. The related deferred tax asset was $65,926 and $43,234 at
June 30, 1998 and 1997, respectively.

NOTE 16 - 1993 MANAGEMENT RECOGNITION AND RETENTION PLAN AND TRUST
               ---------------------------------------------------

   The Bank established the 1993 MRP as a method of providing directors,
officers and other key employees of the Bank with a proprietary interest in the
Bank in a manner designed to encourage such persons to remain with the Bank. The
Bank contributed funds to the 1993 MRP to enable it to acquire 3% of the shares
of Bank Common Stock issued to the public in connection with the MHC
Reorganization.

   A committee of the nonemployee directors administers the trust and makes
awards to officers; however, awards to nonemployee directors are fixed under the
1993 MRP. Under the 1993 MRP, awards are granted to directors and officers in
the form of shares of Bank Common Stock to be held in trust under the 1993 MRP.
Awards are nontransferable and nonassignable. Participants were granted awards
at the time of the completion of the MHC Reorganization which awards vest on a
five-year schedule at a rate of twenty percent per year. No awards under the
1993 MRP shall exceed the Benefit Plan Limitations (as defined). The Committee
may provide for a less or more rapid vesting with respect to awards granted
under the 1993 MRP. Awards will be one hundred percent vested upon termination
of employment due to death, disability, retirement at age seventy or following a
change in control (as defined).

   In the event that an employee terminates employment or a director ceases to
serve with the Bank, the employee's or director's nonvested awards will be
forfeited. When shares become vested in accordance with the 1993 MRP, the
participants recognize income equal to the fair market value of the Bank Common
Stock at that time. The amount of income recognized by the participants will be
a deductible expense for tax purposes for the Bank. When shares become vested
and are actually distributed in accordance with the 1993 MRP, the participants
will also receive amounts equal to any accrued dividends with respect thereto.
Prior to vesting, recipients of awards may direct the voting of the shares
allocated to them. Unallocated shares will be voted by the 1993 MRP trustees.
Earned shares are distributed to recipients as soon as practicable following the
day on which they are earned.

   During the year ended June 30, 1997, all shares under this plan were
exercised and issued as fully vested shares.

NOTE 17 - EMPLOYMENT AGREEMENT
          --------------------

      In August, 1996, the Bank entered into an employment agreement (the
"Employment Agreement") with Mr. James J. Shoffner (the "Employee") who serves
as its President, Chief Managing Officer and as a director. The Board believes
that the Employment Agreement assures fair treatment of the Employee in his
career with the bank by assuring him of some financial security. Pursuant to an
amendment to the Employment Agreement, the Company will become joint and
severally liable with the Bank for its obligations under the employment
agreement.



                                      69
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 17 - EMPLOYMENT AGREEMENT (CONTINUED)
          -------------------------------- 

   The Employment Agreement provides for a term of three years, with the
Employee's annual base salary equal to $55,000. On each anniversary date of the
commencement of the Employment Agreement, the term of the Employee's employment
will be extended for an additional one-year period beyond the then effective
expiration date, upon a determination by the Board of Directors that the
performance of the Employee has met the required performance standards and that
such Employment Agreement should be extended. The Employment Agreement provides
the Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave. The
Employment Agreement shall terminate upon the Employee's death, may terminate
upon the Employee's disability and is terminable by the Bank for "just cause"
(as defined in the Employment Agreement). In the event of termination for just
cause, no severance benefits are available. If the Bank terminates the Employee
without just cause, the Employee will be entitled to a continuation of his
salary and benefits from the date of termination through the remaining term of
the Employment Agreement and at the Employee's election, either continued
participation in benefits plans which the Employee would have been eligible to
participate in through the Employment Agreement's expiration date or the cash
equivalent thereof. If the Employment Agreement is terminated due to the
Employee's "disability" (as defined in the Employment Agreement), the Employee
will be entitled to a continuation of his salary and benefits through the date
of such termination, including any period prior to the establishment of the
Employee's disability. In the event of the Employee's death during the term of
the Employment Agreement, his estate will be entitled to receive his salary
through the last day of the calendar month in which the Employee's death
occurred. The Employee is able to voluntarily terminate his Employment Agreement
by providing ninety days written notice to the Boards of Directors of the Bank
and the Company, in which case the Employee is entitled to receive only his
compensation, vested rights and benefits up to the date of termination.

   In the event of (i) the Employee's involuntary termination of employment
other than for just cause during the period beginning six months before a Change
in Control (as defined) and ending on the later of the first anniversary of the
Change in Control or the expiration date of the Employment Agreement (the
"Protected Period"), (ii) the Employee's voluntary termination within ninety
days of the occurrence of certain specified events occurring during the
Protected Period which have not been consented to by the Employee, or (iii) the
Employee's voluntary termination of employment for any reason within the
thirty-day period beginning on the date of the Change in Control, the Employee
will be paid within ten days of such termination (or the date of the Change in
Control, whichever is later) an amount equal to the difference between (i) 2.99
times his "base amount," as defined in Section 28OG(b)(3) of the Code, and (ii)
the sum of any other parachute payments, as defined under Section 28OG(b)(2) of
the Code, that the Employee receives on account of the Change in Control. The
Employment Agreement with the Bank provides that within ten business days of a
Change in Control, the Bank shall fund, or cause to be funded, a trust in the
amount of 2.99 times the Employee's base amount, that will be used to pay the
Employee amounts owed to him. These provisions may have an anti-takeover effect
by making it more expensive for a potential acquiror to obtain control of the
Company. In the event that the Employee prevails over the Company and the Bank,
or obtains a written settlement in a legal dispute as to the Employment
Agreement, he will be reimbursed for his legal and other expenses.



                                       70
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 17 - EMPLOYMENT AGREEMENT (CONTINUED)
          --------------------------------

   The Employment Agreement entitles Mr. Shoffner to receive supplemental
retirement benefits upon his termination of employment with the Bank, for
reasons other than removal for just cause. Benefits are payable for his life in
an annual amount equal to (i) the product of his vested percentage (i.e., 20%
per year of service under the agreement, up to 100%) and 80% of the average of
the highest compensation for three of the five calendar years preceding
termination, less (ii) the sum of the 50% joint and survivor annuity value of
his employer provided benefits under the Bank's tax-qualified retirement plans
and his annual social security benefit at age 62. Vesting accelerates to 100%
upon his death or disability. Upon Mr. Shoffner's death, his surviving spouse
would receive a lump-sum payment equal to 50% of the present value of his unpaid
retirement benefits.

   At June 30, 1998 and 1997, the accrual for the estimated benefits payable
under this agreement was $60,990 and $28,500, respectively.

NOTE 18 - EMPLOYEE STOCK OWNERSHIP PLAN
          -----------------------------

      The Company sponsors a leveraged employee stock ownership plan (ESOP)
that covers all employees who work forty or more hours per week. The Company
makes annual contributions to the ESOP equal to the ESOP's debt service less
dividends received by the ESOP. All dividends received by the ESOP are used to
pay debt service. The ESOP shares initially are pledged as collateral for its
debt. As the debt is repaid, shares are released from collateral and allocated
to active employees, based on the proportion of debt service paid in the year.
The debt of the ESOP is recorded as debt and the shares pledged as collateral
are deducted from stockholders' equity as unearned ESOP shares in the
accompanying consolidated balance sheet.

      As shares are released from collateral, the Company reports compensation
expense equal to the current market price of the shares and the shares become
outstanding for earning-per-share (EPS) computations. Dividends on allocated
ESOP shares are recorded as a reduction of retained earnings; dividends on
unallocated ESOP shares are recorded as a reduction of debt and accrued
interest. There was no ESOP compensation expense for the years ended June 30,
1998 and 1997.

<TABLE> 
<CAPTION> 
        Shares of the Company held by the ESOP at June 30, 1998 are as follows:
            <S>                                                                       <C> 
            Allocated shares                                                                     -
            Shares released for allocation                                                       -
            Unreleased (unearned) shares                                                   120,379
                                                                                      ------------
                                                                                           120,379
                                                                                      ============
            Fair value of unreleased (unearned) shares                                $  1,971,206
                                                                                      ============
</TABLE> 


                                       71
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 19 - INCENTIVE COMPENSATION PLAN
          ---------------------------

   Effective July 1, 1996, the Company's Board of Directors implemented an
incentive compensation plan (the "Incentive Compensation Plan"). The Incentive
Compensation Plan is unfunded and benefits are payable only in the form of cash
from the Company's general assets. The Incentive Compensation Plan is
administered by the Compensation Committee (the "Committee") consisting of the
Company's non-employee directors. All employees who are with the Bank on the
first and the last day of the plan year are eligible to participate in the
Incentive Compensation Plan.

   A mathematical formula set forth in the Incentive Compensation Plan, and
summarized below, determines the amount of each participant's annual cash
bonuses ("bonuses"). Nevertheless, the Committee may in its discretion
determine, by resolution adopted before the first day of any plan year, to
change the employees participating in the Incentive Compensation Plan, and the
formula for calculating the bonuses. Absent such action, for each plan year in
which the Incentive Compensation Plan is in effect, the bonus pool will equal
$35,000 times the return-on- average assets ("ROAA") times the Safety and
Soundness Factor ("SSF") (which takes into account the Company's nonperforming
assets ("NPA") and its CAMEL ratings). ROAA will be calculated each year on a
consolidated financial basis on a pre-dividend, pre-provision for loan loss and
pre-plan payment basis. ROAA factor will equal the square of the ratio of (i)
the Bank's return on average assets for the plan year to (ii) 0.8%. The
Committee may adjust the Company's and the Bank's ROAA or NPA to take into
account extraordinary financial events. The aggregate amount of Bonuses payable
for any calendar year will be proportionately reduced (to zero, if necessary) to
the extent that the payment would cause the Bank to cease to be a
"well-capitalized" institution for the year. The Incentive Compensation Plan
provides that no Bonuses will be paid for any year in which ROAA is less than
0.5%. Eighty percent of the bonus pool is expected to be divided among employees
based on relative compensation amounts and the other twenty percent based on the
Committee's discretion. Directors would be permitted to make deferral elections
with respect to directors' fees, and to have the rate of return on their
deferral be measured by the highest 12 month certificate of deposit rate paid by
the Bank.

   The Incentive Compensation Plan has an indefinite term, and the Bank has
the right at any time to terminate or amend the Incentive Compensation Plan for
any reason; provided, that no amendment or termination shall, without the
consent of a participant or, if applicable, the participant's beneficiary,
adversely affect such participant's or beneficiary's rights with respect to
benefits accrued as of the date of such amendment or termination. The bonus
accrued was $9,000 and $61,104 for the years ended June 30, 1998 and 1997,
respectively.

NOTE 20 - ADVANCES FROM FHLB
          ------------------

   At June 30, 1998, 1997 and 1996, the Company has outstanding advances from
the Federal Home Loan Bank of $26,000,000, $13,000,000 and $1,000,000,
respectively. Twenty-one million dollars of advances bear interest at a rate of
6.45% and mature within the next year. Five million dollars of advances bear
interest at a rate of 6.08% and mature March, 2003.



                                       72
<PAGE>
 
             CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                             Middlesboro, Kentucky

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                 June 30, 1998

NOTE 21 - DEFERRED COMPENSATION
          ---------------------

   The Company has an unfunded deferred compensation agreement with a former
officer that provides additional benefits upon retirement. The plan specifies a
benefit of $1,000 per month for fifteen years from the date of his retirement,
which was December 31, 1993. If he does not live to receive all of his deferred
compensation, the unpaid balance at the time of his death shall be forfeited. He
is required to perform various future services under this agreement for the
fifteen year term. A life insurance policy has been purchased on his life to
reimburse the Company for the net cost of the deferred compensation. The amount
expensed under this agreement at June 30, 1998, 1997 and 1996, was $12,000.

   The Company specified an annual salary of $52,000 for Mr. Roy Shoffner. He
has elected to defer this annual salary. At June 30, 1998, $52,000 has been
accrued under this contract and this liability and the related deferred tax
asset of $17,680 are recognized in these financial statements.

   In connection with a deferred compensation agreement between the Company
and another former officer, provision has been made for the future compensation
which is payable over the next twenty years. At June 30, 1998 and 1997, $145,915
and $150,027, respectively, has been accrued under this contract and this
liability and the related deferred tax asset of $49,611 and $51,009,
respectively are recognized in the financial statements. The Company is the
owner and beneficiary of a life insurance policy aggregating $200,000 on the
life of this employee. The policy had an aggregate cash surrender value of
$8,447 and $4,110 at June 30, 1998 and 1997, respectively.

NOTE 22 - 1993 STOCK OPTION PLAN
          ----------------------

   In connection with the MHC Reorganization, the Bank's Board of Directors
adopted the 1993 Option Plan, pursuant to which a number of shares equal to ten
percent of the Bank Common Stock issued to the public in the formation of the
Mutual Holding Company (18,000 shares) were reserved for future issuance by the
Bank upon exercise of stock options to be granted to directors and employees of
the Bank from time to time under the 1993 Option Plan. The purpose of the 1993
Option Plan is to provide additional incentive to certain directors, officers
and key employees by facilitating their purchase of a stock interest in the
Bank. The 1993 Option Plan, which became effective upon the completion of the
MHC Reorganization, has a term of ten years, unless earlier terminated by the
Board of Directors. Upon consummation of the Conversion and Reorganization, the
1993 Option Plan became an option plan of the Company and each outstanding
option was converted into the right to purchase shares of Common Stock on the
same terms and conditions.

   The 1993 Option Plan is administered by a committee of at least three
non-employee directors of the Bank, who are appointed by the Bank's Board of
Directors (the "Option Committee"). The Option Committee selects the employees
to whom options are granted and the number of shares granted. The Bank receives
no monetary consideration for the granting of stock options under the 1993
Option Plan other than the option price for each share issued to optionees upon
exercise of such options. The initial grant of options under the 1993 Option
Plan took place upon completion of the MHC Reorganization, and the option
exercise price was equal to the purchase price of the



                                       73
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 22 - 1993 STOCK OPTION PLAN (CONTINUED)
          ----------------------------------

Bank Common Stock in the MHC Reorganization. No awards under the 1993 Option
Plan shall exceed the following percentage limitations (the "Benefit Plan
Limitations"), determined with respect to the total shares reserved for awards
under the 1993 Option Plan: 25% for total awards to any particular employee, 5%
for total awards to any particular non-employee director, and 30% for total
awards to the non-employee directors as a group.

     The 1993 Option Plan provides that, in the event of a Change in Control of
the Bank or the Company (as defined), any option which provides for its exercise
in installments shall become immediately exercisable, and the optionee shall, at
the discretion of the Option Committee, be entitled to receive cash in an amount
equal to the excess of the fair market value of the Bank Common Stock subject to
the option over the option price in exchange for the surrender of the option.

     It is intended that options granted under the 1993 Option Plan will
constitute both incentive stock options (options that afford favorable tax
treatment to recipients upon compliance with certain restrictions pursuant to
Section 422 of the Code and that do not normally result in tax deductions to the
Bank until the stock is sold) and options that do not so qualify. The option
price may not be less than 100% of the fair market value of the shares on the
date of the grant, and no option shall be exercisable after the expiration of
ten years from the date it is granted; provided, however, that in the case of
any employee who owns more than 10% of the outstanding Bank Common Stock at the
time the option is granted, the option price may not be less than 110% of the
fair market value of the shares on the date of the grant, and the option shall
not be exercisable after the expiration of five years from the date it is
granted. For the purpose of options granted in connection with the formation of
the Mutual Holding Company, the offering price of $10.00 per share was
considered the market value of the shares subject to such options; for the
purpose of any options granted in the future, the market value of the underlying
shares on the date of grant is determined with reference to the then-recent
trading prices known to management or such other reasonable basis as the Option
Committee may select. Option shares may be paid for in cash, shares of the Bank
Common Stock or a combination of both. In the event that the fair market value
per share of the Bank Common Stock falls below the price of previously granted
options but not less than 75% of the Option Price when first issued, the
Committee shall have the authority, with the consent of the optionee, to cancel
outstanding options and to reissue new options at the then current fair market
price per share of the Bank Common Stock.

     An optionee will not be deemed to have received taxable income upon grant
or exercise of any incentive stock option, provided that such shares are not
disposed of by the optionee for at least one year after the date of exercise and
two years after the date of grant. No compensation deduction may be taken by the
Bank as a result of the grant or exercise of incentive stock options. In the
case of a non-incentive stock option, an optionee will be deemed to receive
ordinary income upon exercise of the stock option in an amount equal to the
amount by which the exercise price is exceeded by the fair market value of the
Bank Common Stock purchased by exercising the option on the date of exercise.
The amount of any ordinary income deemed to be received by an optionee upon the
exercise of an incentive stock option prior to the expiration of two years from
the date the incentive option was granted and one year from the date the Bank
Common Stock was so acquired will be deductible expense for tax purposes for the
Bank.

     During the year ended June 30, 1997, all options were granted under this
plan.

                                       74
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 23 - EARNINGS PER SHARE
          ------------------

     Earnings per share has been computed by dividing net income by the weighted
average common and common equivalent shares outstanding during the period. The
weighted average common and common equivalent shares outstanding has been
adjusted to include the number of shares that would have been outstanding if the
stock options granted had been exercised, with the proceeds being used to buy
shares from the market. Earnings per share represents both basic and diluted per
share information.

NOTE 24 - REGULATORY CAPITAL REQUIREMENT
          ------------------------------

     The Company and the Bank are required to comply with the capital adequacy
standards established by the Office of Thrift Supervisory (OTS). There are three
basic measures of capital adequacy for banks that have been promulgated; two
risk-based measures and a leverage measure. All applicable capital standards
must be satisfied for a bank holding company to be considered in compliance.

     The minimum guidelines for the ratio ("Risk-Based Capital Ratio") of total
capital ("Total Capital") to risk weighted assets (including certain
off-balance-sheet items, such as standby letters of credit) is 8.0%. At least
half of Total Capital (i.e., 4.0% of risk-weighted assets) must comprise common
stock, minority interests in the equity account of consolidated subsidiaries,
noncumulative perpetual preferred stock, and a limited amount of cumulative
perpetual preferred stock, less goodwill and certain other intangible assets
("Tier I Capital"). The remainder may consist of subordinated debt, other
preferred stock, and a limited amount of loan loss reserves ("Tier 2 Capital").

     Failure to meet capital guidelines could subject a bank or a bank holding
company to a variety of enforcement remedies, including issuance of a capital
directive, the termination of deposit insurance by the FDIC, a prohibition on
the taking of brokered deposits, and certain other restrictions on its business.
Substantial additional restrictions can be imposed upon FDIC-insured depository
institutions that fail to meet applicable capital requirements under the federal
prompt corrective action regulations.

     As of June 30, 1998, 1997 and 1996, the Bank were considered "well
capitalized" under the federal banking agencies for prompt corrective action
regulations. The table which follows sets forth the amounts of capital and
capital ratios of the Bank as of June 30, 1998, 1997 and 1996, and the
applicable regulatory minimums (in thousands):

                                       75
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 24 - REGULATORY CAPITAL REQUIREMENT (CONTINUED)
          ------------------------------------------

<TABLE> 
<CAPTION> 
                                                    1998                 1997                  1996
                                            -----------------     -----------------     ------------------
                                            Amount      Ratio     Amount      Ratio     Amount       Ratio
                                            ------      -----     ------      -----     ------       ----- 
<S>                                         <C>         <C>       <C>         <C>       <C>          <C> 
Tangible Capital Requirement:                                                        
      Actual                                $  8,840     6.50%    $  8,655     7.54%    $  4,901      6.53% 
      Minimum required                         2,040     1.50        1,721     1.50        1,125      1.50  
                                            --------    -----     --------    -----     --------     -----  
      Excess over minimum                   $  6,800     5.00     $  6,934     6.04     $  3,776      5.03  
                                            ========    =====     ========    =====     ========     =====  
                                                                                                            
Core Capital Requirement:                                                                                   
      Actual                                $  8,840     6.50     $  8,655     7.54     $  4,901      6.53  
      Minimum required                         5,439     4.00        4,592     4.00        3,000      4.00  
                                            --------    -----     --------    -----     --------     -----  
      Excess over minimum                   $  3,401     2.50     $  4,063     3.54     $  1,901      2.53  
                                            ========    =====     ========    =====     ========     =====  
                                                                                                            
Risk-Based Capital Requirement:                                                                             
      Actual                                $  9,639    10.04     $  8,961    11.36     $  5,081     11.62  
      Minimum required                         7,681     8.00        6,309     8.00        3,499      8.00  
                                            --------    -----     --------    -----     --------     -----  
      Excess over minimum                   $  1,958     2.04     $  2,652     3.36     $  1,582      3.62  
                                            ========    =====     ========    =====     ========     =====  
</TABLE> 

NOTE 25 - PARENT COMPANY FINANCIAL STATEMENTS
          -----------------------------------

         Condensed financial statements of the Company (Cumberland Mountain
Bancshares, Inc.) are presented below. Amounts shown as investment in the
wholly-owned subsidiaries and equity in earnings of the subsidiaries are
eliminated in consolidation.

<TABLE> 
<CAPTION> 
                                 BALANCE SHEETS
                                 --------------
                                     ASSETS
                                     ------
                                                                                1998                  1997  
                                                                                ----                  ----   
     <S>                                                                   <C>                   <C>  
     Cash                                                                  $     393,972         $      11,662
     Investment in wholly-owned subsidiaries                                  10,641,915             8,414,107
     Other investments                                                           108,340                88,318
                                                                           -------------         -------------
                                             TOTAL ASSETS                  $  11,144,227         $   8,514,087
                                                                           =============         =============
<CAPTION> 

                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                                                                1998                  1997  
                                                                                ----                  ----   
     <S>                                                                   <C>                   <C>  
     Accounts payable and accrued expenses                                 $     723,375         $           -
     Notes payable                                                             1,660,017                     -
                                                                           -------------         ------------- 
                                             Total liabilities             $   2,383,392                     -
                                                                           -------------         ------------- 
</TABLE> 

                                       76
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998

NOTE 25 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
          -----------------------------------------------

<TABLE> 
<CAPTION> 
                                                                                            1998               1997    
                                                                                            ----               ----    
     <S>                                                                             <C>                <C>            
     Common stock                                                                    $       6,788      $       6,788  
     Unearned ESOP shares                                                               (1,552,797)          (986,423) 
     Paid-in capital                                                                     5,541,930          5,541,930  
     Retained earnings                                                                   4,844,981          4,093,620  
     Net unrealized gains (losses) on available for sale securities                                                    
         net of tax effect                                                                 (80,067)          (141,828) 
                                                                                     -------------      -------------  
                                 Total stockholders' equity                              8,760,835          8,514,087  
                                                                                     -------------      -------------  
                                                                                                                       
                                 TOTAL LIABILITIES AND                                                                 
                                 STOCKHOLDERS' EQUITY                                $  11,144,227      $   8,514,087  
                                                                                     =============      =============  
<CAPTION>                                                                                                              
                                                                                                                       
                                 STATEMENTS OF INCOME                                                                  
                                 --------------------                                                                  
     <S>                                                                             <C>                <C>            
     INCOME (EXPENSE)                                                                                                  
        Investment income                                                            $      12,101      $           -  
        Gain (loss) on sale of investment securities                                       112,544                  -  
        Equity in undistributed net income of subsidiaries                                 766,586            408,970  
        Interest expense                                                                   (81,082)               (20) 
        Compensation                                                                       (52,000)                 -  
        Miscellaneous expenses                                                              (6,787)                 -  
                                                                                     -------------      -------------  
             Net income                                                              $     751,362      $     408,950  
                                                                                     =============      =============   
<CAPTION> 

                              STATEMENTS OF CASH FLOWS
                              ------------------------
     <S>                                                                             <C>                <C>          
     CASH FLOWS FROM OPERATING ACTIVITIES                                                                            
        Net income                                                                   $     751,362      $     408,950 
        Reconciliation of net income to net cash provided by operating activities:
            Equity in undistributed net income of subsidiary                              (751,290)          (408,970)
            Gain (loss) on sale of investment securities                                  (112,544)                 -
            Increase in accounts payable and accrued expenses                              723,375                  -
                                                                                     -------------      -------------
                   Net cash provided by (used in) operating activities                     610,903                (20)
                                                                                     -------------      -------------
                                                                                                                     
     CASH FLOWS FROM INVESTING ACTIVITIES                                                                            
        Purchase of investments                                                         (3,651,797)           (88,318)
        Sales of investment securities                                                   3,644,154                  -
                                                                                     -------------      -------------
                   Net cash provided by (used in) investing activities                      (7,643)           (88,318)
                                                                                     -------------      ------------- 
</TABLE> 

                                       77
<PAGE>
 
              CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
                              Middlesboro, Kentucky

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 1998



NOTE 25 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
          -----------------------------------------------

<TABLE> 
<CAPTION> 
                                                                                  1998                  1997
                                                                                  ----                  ----
<S>                                                                        <C>                   <C> 
     CASH FLOWS FROM FINANCING ACTIVITIES
          Dividends received from subsidiary                                     400,000                     -
          Distribution of cash in reorganization                                       -               100,000
          Proceeds from borrowings                                             1,000,000                     -
          Payments on borrowings                                                 (54,576)                    -
          Purchase of stock for ESOP plan                                       (566,374)                    -
          Additional investment in subsidiary                                 (1,000,000)                    -
                                                                           -------------         -------------
                    Net cash provided by (used in) financing activities         (220,950)              100,000
                                                                           -------------         -------------

     NET INCREASE (DECREASE) IN CASH                                             382,310                11,662

     CASH, BEGINNING OF PERIOD                                                    11,662                     -
                                                                           -------------         -------------

     CASH, END OF PERIOD                                                   $     393,972         $      11,662
                                                                           =============         =============
</TABLE> 

NOTE 26 - YEAR 2000
          ---------

     The Company has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the Year 2000 Issue and is
developing an implementation plan to resolve the issue. The Year 2000 Issue is
the result of computer programs being written using two digits rather than four
to define the applicable year. Any of the Company's programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a major system failure or
miscalculations. The Company presently believes that, with modifications to
existing software and conversions to new software, the Year 2000 problem will
not pose significant operational problems for the Company's computer systems as
so modified and converted. However, if such modifications and conversions are
not completed timely, the Year 2000 problem may have a material impact on the
operations of the Company.

NOTE 27 - LOAN SERVICING
          -------------- 

     The Company sold $2,783,000 of loans and retained servicing rights ranging
from .125% to .25%. There was no servicing asset or liability recorded because
the Company estimated that the benefits of servicing are just adequate to
compensate for its servicing responsibilities. Servicing income for June 30,
1998 was $4,289.

                                       78
<PAGE>
 
Item 8. Changes in and Disagreements with Accountants on Accounting and
-----------------------------------------------------------------------
Financial Disclosure
--------------------

     Not applicable.

                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
--------------------------------------------------------------------------------
with Section 16(a) of the Exchange Act
--------------------------------------

     For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal I
-- Election of Directors" in the Company's definitive proxy statement for the
Company's 1998 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.

     Information required by Item 405 of Regulation S-B is incorporated by
reference from the section captioned "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.

Item 10.  Executive Compensation
--------------------------------

     The information contained under the section captioned "Executive
Compensation" in the Proxy Statement is in corporated herein by reference.

Item 11.  Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------

     (a) Security Ownership of Certain Beneficial Owners

         The information required by this item is incorporated herein by
         reference to the section captioned "Voting Securities and Principal
         Holders Thereof" in the Proxy Statement.

     (b) Security Ownership of Management

         The information required by this item is incorporated herein by
         reference to the section captioned "Proposal I -- Election of
         Directors" in the Proxy Statement.

     (c) Changes in Control

         Management of the Company knows of no arrangements, including any
         pledge by any person of securities of the Bank, the operation of which
         may at a subsequent date result in a change in control of the
         registrant.

Item 12.  Certain Relationships and Related Transactions
--------------------------------------------------------

     The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.

Item 13.  Exhibits List and Reports on Form 8-K
-----------------------------------------------

         (a)      List of Documents Filed as Part of This Report
                  ----------------------------------------------

                  (1)      Consolidated Financial Statements. The following
                           financial statements of the registrant are included
                           herein under Item 7. The remaining information
                           appearing in the Annual Report is not deemed to be
                           filed as part of this Annual Report on Form 10-KSB,
                           except as expressly provided herein.

                                       79
<PAGE>
 
                           1.       Independent Auditor's Report

                                    (a) Consolidated Balance Sheets as of June
                                        30, 1998, 1997 and 1996 
                                    (b) Consolidated Statements of Income for
                                        the Years Ended June 30, 1998, 1997 and
                                        1996
                                    (c) Consolidated Statements of Stockholders'
                                        Equity for the Years Ended June 30,
                                        1998, 1997 and 1996
                                    (d) Consolidated Statements of Cash Flows
                                        for the Years Ended June 30, 1998, 1997
                                        and 1996
                                    (e) Notes to Consolidated Financial
                                        Statements

                  (2)      Financial Statement Schedules.  None
                           -----------------------------

                  (3)      Exhibits. The following exhibits are either filed as
                           --------
                           part of this Annual Report on Form 10-KSB or
                           incorporated herein by reference:

                  Exhibit No.

                  3.1      Charter of Cumberland Mountain Bancshares, Inc. *

                  3.2      Bylaws of Cumberland Mountain Bancshares, Inc. *

                  10.1     Employment Agreement between Middlesboro Federal
                           Bank, Federal Savings Bank and James J. Shoffner and
                           amendment *+

                  10.2     Middlesboro Federal Bank, FSB 1993 Stock Option 
                           Plan *+

                  10.3     Middlesboro Federal Bank, FSB 1993 Management
                           Recognition and Retention Plan (As Amended and
                           Restated) *+

                  10.4     Middlesboro Federal Bank, Federal Savings Bank
                           Retirement Plan for Non-Employee Directors *+

                  10.5     Middlesboro Federal Bank, FSB Incentive Compensation
                           Plan *+

                  10.6     Form of indemnification agreements with directors *

                  21       Subsidiaries of Registrant
                
                  23       Consent of Marr, Miller & Myers, P.S.C

                  27       Financial Data Schedule (EDGAR Only)

-----------
* Incorporated by reference from Registration Statement on Form SB-2 filed
  February 5, 1997 (File No. 333-18665) 
+ Management contract or compensatory plan or arrangement required to be filed
  as an exhibit to this Form.

         (b)      Reports on Form 8-K. No current reports on Form 8-K have been
                  -------------------
                  filed during the last quarter of the fiscal year covered by
                  this report.

                                       80
<PAGE>
 
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                       CUMBERLAND MOUNTAIN BANCSHARES,
                                       INC.


Date: September 22, 1998               By: /s/ James J. Shoffner
                                           ---------------------
                                           James J. Shoffner
                                           President and Chief Executive Officer
                                           (Duly Authorized Officer)

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE> 

<S>                                             <C> 
By: /s/ J. Roy Shoffner                         By: /s/ Reecie Stagnolia, Jr.
    --------------------------------                ----------------------------------
    J. Roy Shoffner                                 Reecie Stagnolia, Jr.
    Chairman of the Board                           Director
                                          
Date:  September 22, 1998                       Date:  September 22, 1998
                                          
                                          
By: /s/ James J. Shoffner                       By: /s/ Raymond C. Walker
    --------------------------------                ----------------------------------
    James J. Shoffner                               Raymond C. Walker
    President and Director                          Director
    (Chief Executive Officer)           
                                          
Date:  September 22, 1998                       Date:  September 22, 1998
                                          
                                          
By: /s/ Robert R. Long                          By: /s/ J. D. Howard
    --------------------------------                ----------------------------------
    Robert R. Long                                  J. D. Howard
    Vice Chairman and Director                      Vice President
                                                    (Chief Financial and Accounting Officer)
                                          
Date:  September 22, 1998                       Date:  September 22, 1998


By: /s/ Barry Litton
    --------------------------------  
    Director

Date:  September 22, 1998
</TABLE>